Security markets are considered to be perfect when firms can ...

[vicky]

Security markets are considered to be perfect when firms can issue securities at no cost and the
  investor incurs no brokerage commissions.
 
  Indicate whether the statement is true or false

Question 2

How does internal growth versus the infusion of new capital affect the original shareholders?
 
  What will be an ideal response?

[cadimas]

Answer to Question 1

TRUE

Answer to Question 2

A company can grow in a variety of ways. It can become larger by borrowing money to invest in new projects.
Likewise, it can issue new stock for expansion. Managers can also acquire another company to merge with the existing
firm, which would increase the firm's assets. Although it can accurately be said that the firm has grown, the original
stockholders may or may not participate in this growth. Growth is realized through the infusion of new capital. The
firm size clearly increases, but unless the original investors increase their investment in the firm, they will own a
smaller portion of the expanded business. Another means of growing is internal growth, which requires that managers
retain some or all of the firm's profits for reinvestment in the firm, resulting in the growth of future earnings and,
hopefully, the value of the common stock. This process underlies the essence of potential growth for the firm's current
stockholders and is the primary relevant growth for our purpose of valuing a firm's common shares. We are not
arguing that the existing common stockholders never benefit from the use of external financing; however, such benefit
is nominal if capital markets are efficient.