Although debt financing is usually the cheapest component of capital, it cannot be used in excess because
A) interest rates may change.
B) the firm's stock price will increase and raise the cost of equity financing.
C) the financial risk of the firm may increase and thus drive up the cost of all sources of financing.
D) underwriting costs may change.

Question

Quizplus · Accepted Answer

Excess debt financing can increase the financial risk of the firm, which in turn can increase the cost of all sources of financing. By taking on too much debt, the firm may become unable to meet interest payments or repay the debt when it is due, which poses a risk to investors and creditors. This risk is reflected in a higher cost of capital for all sources of funding. Therefore, it is important for firms to balance their debt and equity financing to maintain an optimal capital structure.

Although Debt Financing Is Usually the Cheapest Component of Capital