Question

An implicit cost of increasing proportion of debt is ___________.

• A. Tax shield would not be available on new debt
• B. P.E. Ratio would increase
• C. Equity shareholders would demand higher return
• D. Rate of Return of the company would decrease

Answer 1

Answer: (C)

Equity shareholders would demand higher return

An implicit cost of increasing the proportion of debt in a firm's capital structure is that:

A) the firm's asset beta will increase.

B) shareholders will demand a higher rate of return.
C) the tax shield will not apply to the added debt.