CFA Level 1: Business Risk, Tax Rates, and Capital Requirements

Business Risk, Tax Rates, and Capital Requirements

Prev Question Next Question

Question

All else equal, which of the following is/are true?

I. Firms with higher business risk tend to have lower debt ratios.

II. The higher the tax rate imposed on a firm, the lower its optimal debt ratio.

III. The lower a firm's future capital requirements, the lower its current debt ratio.

Answers

Explanations

Click on the arrows to vote for the correct answer

A. B. C. D. E. F.

C

The higher the business risk and the future capital requirement, the stronger the balance sheet must be. This is accomplished through a lower reliance on debt.

The higher the tax rate, the higher is the attractiveness of the tax-deductibility of the interest payments on debt. This lowers the after-tax cost of debt, raising the optimal debt ratio.

Prev Question Next Question