Equity in a firm with no debt is called:
A. risky equity.
B. shareholders’ equity.
C. risk-free equity.
D. unlevered equity.
E. levered equity.
The correct answer and explanation is :
The correct answer is D. unlevered equity.
Explanation:
Equity in a firm with no debt is referred to as unlevered equity. This term indicates that the firm is not using any debt financing, and thus, its equity value is not impacted by leverage (i.e., the use of borrowed money). In such a situation, the firm’s capital structure consists only of equity, and the risks associated with debt (such as interest payments and the potential for bankruptcy) do not exist.
Let’s break down the other answer choices to understand why they are incorrect:
- A. Risky equity:
- This term might suggest equity that has a higher risk due to the potential use of debt or external factors that increase volatility. However, in the case of a firm with no debt, there is no added financial leverage, and thus, the equity is not necessarily “risky” in the way this term is often used to describe a firm that uses debt. In fact, the absence of debt might reduce the overall risk.
- B. Shareholders’ equity:
- Shareholders’ equity refers to the ownership value in the firm, which is calculated as total assets minus total liabilities. While all equity is technically shareholders’ equity, this term does not specifically refer to a firm with no debt. Shareholders’ equity exists in both leveraged and unleveraged firms, so this is not the best answer.
- C. Risk-free equity:
- Risk-free equity would imply that the equity carries no risk, which is unrealistic in the context of most firms, even those with no debt. In reality, equity carries some degree of risk, even without debt financing. So, this term is not an appropriate description of equity in a firm without debt.
- E. Levered equity:
- Levered equity refers to the equity in a firm that uses debt as part of its capital structure. The term “levered” signifies the use of leverage, and since the firm in this scenario has no debt, this option is incorrect.
In summary, unlevered equity specifically describes the equity of a firm that has no debt, making D. unlevered equity the correct answer.