A company with a $100 million net income is considering a $200 million debt issue. What would the immediate effect be on equity value assuming stable market conditions?

In this scenario, the company is considering taking on a significant amount of debt, specifically a $200 million debt issue, while it has a net income of $100 million. The immediate effect on equity value is a decrease due to several key financial principles.

When a company increases its leverage by taking on more debt, it typically raises the risk profile of the firm. This is because debt must be repaid regardless of the company's profit cycles, which can create financial strain, especially during downturns. Investors may view this increased risk negatively, leading to a decrease in the perceived equity value of the company.

Moreover, the introduction of additional debt can lead to increased interest expenses. If the company's income does not sufficiently rise to cover these additional expenses, net income could eventually decline. Even in stable market conditions, the anticipation of higher interest obligations can prompt investors to reassess the value of equity downward.

Furthermore, the market often reacts to changes in a company's capital structure. A substantial increase in debt relative to equity can be perceived as a signal that the company is over-leveraging itself, which can lead to reduced stock prices as investors look for more stable investments. Thus, the combination of increased risk and potential future profitability constraints supports the conclusion that equity value would