Assertion: Debt is cheaper but is more risky for a business.
Reasoning: The payment of interest and the return of principal is obligatory for the business. Any default in meeting these commitments may force the business to go into liquidation.
Answer & explanation
Correct answer: option 1
Debt is cheaper but is more risky for a business because the payment of interest and the return of principal is obligatory for the business. Any default in meeting these commitments may force the business to go into liquidation. There is no such compulsion in case of equity, which is therefore, considered riskless for the business. Higher use of debt increases the fixed financial charges of a business. As a result, increased use of debt increases the financial risk of a company. Financial risk is the chance that a firm would fail to meet its payment obligations.