Using debt and preferred stock in the capital structure of a firm will _____.
A) increase financial risk
B) decrease business risk
C) increase the tax payableby the firm.
D) decrease operating leverage
E) increase the book value of common stock

Question

Quizplus · Accepted Answer

Using debt and preferred stock increases the financial risk of a firm because these instruments require fixed payments regardless of the company's profitability, which can create a burden if earnings or cash flows decline. This can increase the likelihood of default or bankruptcy, which is why these forms of financing tend to have higher required rates of return (costs of capital) than equity or retained earnings (which don't have fixed payments). Using debt and preferred stock can also decrease the flexibility of a company to adjust its dividend policy or invest in new projects, since it must prioritize these fixed obligations.

Using Debt and Preferred Stock in the Capital Structure of a Firm