Which of following is NOT a step that should be taken to minimize risk associated with...

Which of following is NOT a step that should be taken to minimize risk associated with long-term debt? A company should Select one: a. conduct a thorough business analysis when a decision is made to borrow money b. make sure that there is a high probability of positive financial leverage c. maximize its debt-to-equity ratio d. evaluate the characteristics of the various types of debt

Solutions

Expert Solution

Correct Answer : Option c : Maximize its debt-to-equity ratio.

Explanation :

Option a is incorrect as conducting a thorough business analysis before borrowing money helps to determine the business' debt honoring capacity in terms of principal repayment and interest payments. Hence, it can be used to minimize risk associated with long term debt.

Option b is incorrect as a high probability of positive financial leverage (EBIT / PBT) means good interest coverage ratio and signifies strong capacity to honor debt. Hence, it minimizes financial risk.

Option c is correct as maximizing debt-to-equity ratio means maximizing debt and minimizing equity signifies 100% leverage which carries huge financial risk. Hence, it cannot be used to minimize risk associated with long-term debt.

Option d is incorrect as evaluating the characteristics of the various types of debts helps the firm to identify and select the most suitable debt type for its business, thus leading to a better decision on debt. Hence, it can reduce risk associated with long term debt.

ekkarill92 answered 1 year ago

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