Suppose that managers of XYZ think their firm's shares are currently overvalued, and

suppose that their sole objective is to maximize value for their ongoing, long-term share holders.

(i) Assume that managers of XYZ decide to raise some capital through either (a) equity

or (b) debt. Which will they prefer? Why?

(ii) Under policy (a) in part (i), how would new shareholders be affected in the long-run?

Discuss some empirical evidence that is consistent with your prediction (by empirical ev idence, I mean some historical evidence based on data - the relevant evidence has been

discussed in class and can be found in the slides).

(iii) Now assume that managers of XYZ can invest the new capital in either (a) cash

or (b) the typical assets of their firm. Which will they prefer? Why?