Investors typically accept a lower risk-adjusted rate of return on debt capital than on equity capital because:
A) debt is typically less risky because fixed claims bear less residual risk than equity claims.
B) equity bears less residual risk than debt.
C) equity capital costs are tax deductible.
D) the yield to maturity on equity is inversely related to its market value.

Question

Quizplus · Accepted Answer

Debt holders have fixed claims on the company's assets and cash flows, which means they bear less residual risk than equity holders. This makes debt a less risky investment, and investors are willing to accept a lower rate of return in exchange for the lower risk.

Investors Typically Accept a Lower Risk-Adjusted Rate of Return on Debt