Which of the following sources of capital should not be selected by a company if its fixed cost is high?

Debentures Preference shares Both 1 and 2 None of the above

Debentures

Use of debt increases the financial risk of a business. 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. Thus, if the fixed cost is high, the company should raise capital by way of share capital and not by debentures.