Which of the following is a valid reason for a firm not to use as much debt as it can raise?

Question

Quizplus · Accepted Answer

The use of more debt is expected to result in an increase in the firm's cost of capital when everything is considered. This is because lenders will demand a higher rate of return to compensate for the increased risk of default. Option A is incorrect as a lower price/earnings ratio may not necessarily be a bad thing for the firm. Option C is also incorrect as it is not a reason for the firm to use less debt, but rather a risk associated with using more debt. Using more debt than the optimal level can result in an increase in the firm's cost of capital when everything is considered. This may cause an increase in financial risk and lower the credit rating of the firm, resulting in higher interest rates and a more significant cost of capital. Therefore, a firm may choose to use less debt than it can raise to avoid the potentially negative effects on its cost of capital. Option A is incorrect because a lower price/earnings ratio may not always be disadvantageous. Option C is incorrect because increasing a firm's riskiness is unlikely to be viewed positively. Option D is incorrect because it is an incorrect statement which does not present a valid reason for a firm to use less debt than available.

Which of the Following Is a Valid Reason for a Firm