Question

Explain the following as factors affecting the choice of capital structure:

Risk Consideration

Answer 1

Risk Consideration: Debt involves financial risk in the sense that there is the compulsion to repay the debt amount in a fixed period of time. Any default in repayment may even lead to the liquidation of the firm. As against this, in case of equity, there is no such risk as it is not mandatory to pay dividends to shareholders.
Higher financial and operating risks ⇒ Lower proportion of debt
Lower financial and operating risks ⇒ Higher proportion of debt