Question

1. Since debt is the cheapest source of financing for the firm, all firms should obtain 99% of their financing from debt and only 1% from equity. True or false and explain your answer.  Hint – review the material on capital structure before attempting to answer.

Answer 1

This is a false statement because form should not be obtaining 99% of financing from debt and only 1% from equity, because there should always be a focus on achievement of the optimum capital mix which will be combining an optimal structure of debt capital and an optimal structure of equity capital.

Debt capital are generally preferred because they are having a tax deduction element associated with the interest payments so they are often used by many companies who are generating a higher rate of return than the cost of capital but when the companies are not able to generate a higher rate of return than the debt capital, It is having a lot of risk on the solvency of the company resulting into cost of financial distress because it has fixed payment associated with it.

Given statement is FALSE.