QUESTION6 100000 p The use of debt intensifies the firms bus

QUESTION6 1.00000 p The use of debt intensifies the firm\'s business risk borne by the common stockholders. As a result, shareholders of a firm with higher debt ratio would require a higher return compared to a similar firm without debt. True O False

Solution

Answer: This statement is true.

If a firm\'s debt ratio is higher, it means firm has higher amount of debt in its balance sheet. Higher debt indicates the high risk in the company. Firm has to pay more interest on the debt and its liability increases. Due to higher debt, firm may default in payment of dividend and capital to shareholders so shareholders do not want to invest money into the firm with higher debt until they get some extra return, If firm promises to pay higher return to shareholders then only they invest their money into that highly leveraged firm. As it is sais, More risk, More gain. This formula applies here also.