Using more debt in the firm's capital structure
A) decreases the probability of filing for bankruptcy.
B) raises the riskiness of the firm's earnings stream.
C) generally leads to a lower expected rate of return.
D) none of the above.

Question

Quizplus · Accepted Answer

Using more debt in the firm's capital structure raises the riskiness of the firm's earnings stream because the firm has to make fixed interest payments on the debt regardless of how well it's doing. This can put pressure on the company's cash flow and increase the risk of financial distress. Option A is incorrect because using more debt means the firm has a higher probability of bankruptcy. Option C is incorrect since the use of debt generally leads to a higher expected rate of return, but at higher risk. Option D is incorrect as the above options are correct.

Using More Debt in the Firm's Capital Structure