Financial Management · Class 12 · CBSE · Commerce Business Studies
A company is considering raising a larger proportion of its funds through debt. Its expected return on investment is higher than the interest rate on…
Practice question from Financial Management (Class 12 · CBSE · Commerce Business Studies), with the correct answer and a step-by-step solution.
hard · MCQ · Q-6B1ED0
A company is considering raising a larger proportion of its funds through debt. Its expected return on investment is higher than the interest rate on debt. Which statement is most appropriate?
- A.Debt will always reduce the earnings available to equity shareholders.
- B.Debt may increase earnings per equity share, but it also increases financial risk.Correct answer
- C.Debt has no effect on the financial risk of the company.
- D.Debt eliminates the need for equity shareholders’ funds.
Solution
When the return on investment is higher than the cost of debt, financial leverage may increase the earnings available to equity shareholders. However, debt creates fixed interest obligations, thereby increasing financial risk.
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