Why does a higher proportion of debt in a company’s capital structure usually increase financial risk?
Correct answer: B. Interest and principal payments are contractual obligations
- A. Debt eliminates operating expenses
- B. Interest and principal payments are contractual obligations
- C. Debt always lowers the company’s sales
- D. Interest payments increase ordinary shareholders’ control
Explanation
Debt requires scheduled interest and principal payments even when profits are low. Failure to meet these obligations can cause financial distress. Debt may increase shareholders’ returns, but it does not eliminate operating expenses or guarantee higher sales.
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About Business Finance
Business finance explains how organisations plan, obtain and use money while balancing risk, return and liquidity. Topics include financial statements, time value of money, budgeting, working capital, capital structure, sources of finance, investment appraisal and cost of capital. Capital budgeting evaluates long-term projects, whereas working capital manages day-to-day operations.
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