Question

An implicit cost of increasing proportion of debt is

Answer 1

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 willdemand a higher rate of return. C the tax shield will not apply to the added debt. D the equity-to-value ratio will decrease.

Answer 2

An ‘implicit cost of increasing proportion’ of debt is equity shareholders would ‘demand higher returns’.

Explanation:

• The return on ‘shareholders' equity’ is the money that is returned to the owners as a ‘percentage of the money’ they have invested or kept in the company.  

• The return is calculated by dividing the ‘earnings of the company’ after removing the taxes by the equity of the total number of shareholders in the company.  

• This can be shown through the following formula:

            ROE = Net Income / Shareholders’ Equity