The use of debt financing:
A) may cause a manager to take on riskier projects in order to make interest payments.
B) is more expensive than issuing equity due to the use of covenants.
C) allows managers to make discretionary interest payments.
D) limits the ability of managers to waste shareholder money.

Question

Quizplus · Accepted Answer

Debt financing involves the use of borrowed funds that must be repaid with interest. This means that managers are limited in their ability to waste shareholder money since they are obligated to make interest payments and repay the debt. As a result, debt financing can be an effective way to align the interests of managers with those of shareholders. Choices A and C are not true since managers should always evaluate projects based on their risk and return regardless of the funding source. Choice B is also incorrect since the cost of debt financing is generally cheaper than equity financing due to the tax deductibility of interest payments.

The Use of Debt Financing