Read the following text and answer the following 5 questions on the basis of the same (Q.1)
Mr. Yash Mittal is running a successful business. Mr. Mittal is the owner of Y. K. Cement Ltd. Mr. Mittal decided to expand his business by acquiring a Steel Factory. This required an investment of Rs. 60 crores. To seek advice in this matter, he called his financial advisor Mr. Amit Pathak who advised him about the judicious mix of equity (40%) and Debt (60%). He suggested that employing more of cheaper debt may enhance the EPS. Mr. Pathak also suggested him to take loan from a financial institution as the cost of raising funds from financial institutions is low. Though this will increase the financial risk but will also raise the return to equity shareholders. He also apprised him that issue of debt will not dilute the control of equity shareholders. At the same time, the interest on loan is a tax deductible expense for computation of tax liability. After due deliberations with Mr. Pathak, Mr. Mittal decided to raise funds from a financial institution.
In the context of Debt Equity Ratio, two statements are given:
Assertion (A): The cost of debt is lower than the cost of equity for a firm.   

Reasoning (R): Capital structure of a company affects only the profitability and not the financial risk.

Choose the correct option from below?

Only A is Correct and R is False.

The cost of debt is lower than the cost of equity for a firm because the lender’s risk is lower than the equity shareholder’s risk, since the lender earns an assured return and repayment of capital and, therefore, they should require a lower rate of return. Additionally, interest paid on debt is a deductible expense for computation of tax liability whereas dividends are paid out of after-tax profit. Increased use of debt, therefore, is likely to lower the over-all cost of capital of the firm provided that the cost of equity remains unaffected.

Capital structure of a company affects both the profitability and the financial risk.