Match List-I with List-II.

Choose the correct answer from the options given below:

(A)-(I), (B)-(III), (C)-(II), (D)-(IV)

The correct answer is Option (2) → (A)-(I), (B)-(III), (C)-(II), (D)-(IV).

Cost of debt: A firm’s ability to borrow at a lower rate increases its capacity to employ higher debt. Thus, more debt can be used if debt can be raised at a lower rate.

Tax Rate: Since interest is a deductible expense, cost of debt is affected by the tax rate. A higher tax rate makes debt relatively cheaper and increases its attraction for equity under favorable condition.

Risk Consideration: Financial risk refers to a position when a company is unable to meet its fixed financial charges namely interest payment, preference dividend and repayment obligations. Apart from the financial risk, every business has some operating risk (also called business risk). Business risk depends upon fixed operating costs. Higher fixed operating costs result in higher business risk and vice-versa. The total risk depends upon both the business risk and the financial risk. If a firm’s business risk is lower, its capacity to use debt is higher and vice-versa.

Control: Debt normally does not cause a dilution of control. A public issue of equity may reduce the managements’ holding in the company and make it vulnerable to takeover. This factor also influences the choice between debt and equity especially in companies in which the current holding of management is on a lower side.