Question

How does increasing the weight of debt affect business risk?

Answer 1

Increasing the weight of debt in the capital has the following effects that affect business risk -

1. Fixed commitments in terms of interest and principal repayments reduce the ability of business to bear sudden slowdowns in economy and reduce buffer
2. Interest cost reduces profitability. Which will have an adverse effect when the business is not steady or not growing

However increasing debt rationally also provides various benefits such as tax shield, leverage to grow amongst others