Question

Which of the following statements is (are) correct? A) A large debt obligation limits management's ability...

Which of the following statements is (are) correct?
A) A large debt obligation limits management's ability to use corporate resources in
ways that do not benefit investors.
B) Managers will prefer less debt as it lowers the firm’s risk of missing interest payments and being forced into liquidation.
C) Both A and B are correct.
D) None of the above.

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Homework Answers

Answer #1

Correct option is: C) Both A and B are correct.

Explanation:

A) Large amount of debts entail the corporate to pay the huge amount of its income to be paid as interest expense and make extra burden on company to pay the interest. The fund which may be used by the management for the benefits of investors, gets diverted as interest expense. Hence, a large debt obligation limits management's ability to use corporate resources in ways that do not benefit investors.

B) Higher debts may increase the higher interest payments and it also creates the risk of missing interest payment and other penalties on non-payment of debts, which may land the company into litigation or liquidation processes. Therefore, Managers will prefer less debt as it lowers the firm’s risk of missing interest payments and being forced into liquidation.

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