Question

its argued that firms should have 100% debt. why might this not be the case.

Answer 1

Out of the two main categories of capital sources, namely, equity and debt, debt is cheaper and hence there is an incentive to increase the proportion of debt in the capital structure with a view to minimize the overall cost of capital.

But as the proportion of debt increases beyond a point, considered normal, both the cost of equity and cost of debt will rise. The rise could be more for equity than for debt as, equity holders suffer the most in case of bankruptcy. Hence, the advantage due to debt will get reduced and cost of capital will begin rising.

However, 100% debt is not a possibility as no one would lend money without contribution from owners. If at all lending is done 100%, then the cost of debt would be prohibitive as the lender, who takes all the risks, would charge very high interest rate. Hence, 100% debt is not a possibility.