By adding leverage, the returns on a firm are split between debt holders and equity holders, but equity holder risk increases because ________.
A) interest payments can be rolled over
B) dividends are paid first
C) debt and equity have equal priority
D) interest payments have first priority

Question

Quizplus · Accepted Answer

Interest payments on debt have first priority over equity payments, such as dividends. This means that in the event of financial difficulty, debt holders are paid before equity holders, increasing the risk to equity holders as they may receive nothing if the firm cannot cover its debt obligations.

By Adding Leverage, the Returns on a Firm Are Split