As a general rule, in which of the following situations does borrowin…

The correct answer is Option (1) → When the business needs to finance its growth or expansion.

Option (1) When the business needs to finance its growth or expansion. — Correct. Debt gives a business the leverage it needs to grow. As a general rule, borrowing makes most sense to bolster cash flow or finance growth or expansion. Too much debt, though, can strangle the business.

Option (2) When the business has high fixed operating costs, such as rent. — Incorrect. High fixed operating costs mean high business risk. A firm with high business risk can carry less debt, so it should borrow less.

Option (3) When the volatility in the business’s industry is high. — Incorrect. The higher the volatility in the industry, the less debt a business should have.

Option (4) When a bank is willing to extend more funds to the business. — Incorrect. A lender’s willingness to give funds does not prove that the business is in a strong debt position. Some lenders look more at the collateral than at whether earnings can pay back the debt.