Discuss Briefly:

(a) The more debt a firm issues, the higher interest rate it must pay; thus firms should operate at conservative debt levels.

(b) Given the choice between two investment projects with the same systematic risk and the same expected return, all bondholders would prefer the project with the lower variance and all stockholders would prefer the project with the higher variance.

(c) Black-Sholes is inappropriate for valuing a levered firms equity, the empirical evidence indicates that higher interest rates are associated with lower stock prices.