Which statement is false?

A. The risk-return profile for equity holders is 100% downside and 100% upside.
B. Higher leverage increases the risks for debt and equity holders.
C. Management generally seeks to maximize equity value and thus may take actions that are unfavorable to debtholders.

Correct Answer: A

A is false. The upside potential for shareholders can be unlimited in theory.

B is true. In fact, equity holders have more downside risk, but a much higher upside potential. C is also true.

C is true. Agency costs of debt arise when debtholders place limits on the use of their capital if they believe that management will take actions that favor shareholders instead of debtholders. Debtholders usually place covenants on the use of capital, such as adherence to certain financial metrics, which, if broken, allows the debtholders to call back their capital.