Key Consideration for XYZ Corporation's Rights Offering

Hard Capital Structure Decisions Financial Distress

XYZ Corporation is a mid-sized manufacturing firm experiencing increased financial distress due to a prolonged downturn in demand and rising operational costs. The company's debt-to-equity ratio has significantly increased, and its interest coverage ratio is now below 1.5. As a result, XYZ's management is considering various strategies to alleviate financial distress.

Among the options being evaluated is the potential for engaging in a rights offering to existing shareholders. Management believes that this could bolster the company's equity base, improve its leverage ratios, and restore investor confidence. However, some board members warn that diluting existing shares could further depress the company’s stock price and alienate current shareholders.

Based on this context, which of the following statements best describes a key consideration that XYZ Corporation should weigh when deciding to pursue a rights offering?

A rights offering allows the firm to obtain equity without incurring additional debt, thereby reducing the risk of bankruptcy.

The decision to proceed with a rights offering should be made solely based on the potential to improve investor sentiment, regardless of dilution.

Engaging in a rights offering may exacerbate the firm’s financial distress if the market perceives the need for capital as a sign of weakness.

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