Question

As the firm borrows more and debt becomes riskier, both stockholders and bondholders demand higher rates of return. Thus, by reducing the debt ratio we can reduce both the cost of debt and the cost of equity, making everybody better off.a. True b. False

Answer 1

Answer:True

Explanation:

The debt holders been entitled to return before the equity places, the equity holders at the risk of not getting a return when the debt level is high and this will make them to clamour for more returns when profit is made thereby making it more costly to manage the equity capital.

The higher the debt capital the lower the possibility of the firm meeting his debts obligations as regards interest and capital and the likely of defaults with consequent penalties, which makes it more costly to service the debt capital.