Which of the following statements is true?
A)Bankruptcy costs do not concern shareholders because they are borne entirely by other parties.
B)Debtholders rarely realise the potential for bankruptcy and do not demand a higher rate of interest on their loans in compensation.
C)Debtholders will not demand higher interest rates on loans because in so doing they may increase the likelihood of bankruptcy.
D)For any given level of business risk,the higher the financial risk,the greater the probability of bankruptcy.

Question

Quizplus · Accepted Answer

This statement is true according to the relationship between business risk and financial risk. The higher the financial risk, the higher the probability of bankruptcy, as there are more fixed and variable costs that must be paid, which can lead to default if revenues cannot cover them. A and B are false because bankruptcy costs can affect shareholders, and debtholders may demand higher interest rates to compensate for the risk they are taking. C is also false, as debtholders may demand higher interest rates precisely because they perceive a higher likelihood of bankruptcy.

Which of the Following Statements Is True