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"If there is a coinsurance effect among assets in place and potential projects within the firm,...

"If there is a coinsurance effect among assets in place and potential projects within the firm, the optimal use of debt for the firm may be higher than the sum of the individual project debt capacities." True or false?

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Answer #1

TRUE.

If the co-insurance effect is true, firms that merge may experience financial synergies through combining operations. Furthermore, the combined debt should be safer than before, which should reduce the yield investors demand from the corporation's bonds. This can reduce the cost of issuing new debt for the company, making it cheaper to raise additional funds. Hence, the optimal use of debt for the firm will be higher than the sum of the individual project debt capacities.

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