Question

Which of the following is not considered an advantage of debt?

a) Investors react positively to debt issues
b) Debt creates a tax shield
c) Moderate amounts of debt reduce bankruptcy risk
d) Issuing debt requires less administrative work than issuing equity

Answer 1

Investors do not typically react positively to debt issues.

Step-by-step explanation:

Of the options given, a) Investors react positively to debt issues is not considered an advantage of debt. While debt can provide certain benefits, such as creating a tax shield and reducing bankruptcy risk in moderate amounts, investors do not typically react positively to debt issues. When a company takes on debt, it can be seen as a potential risk to investors because the company will have to make regular interest payments and may have higher financial obligations.

When a company takes on debt, it incurs a legal obligation to make scheduled interest payments irrespective of its income situation. This increases the company's financial leverage but also enhances the risk of bankruptcy. On the other hand, debt creates a tax shield because interest payments are tax-deductible, and it allows for company control to be maintained as there's no need to answer to new shareholders as would be the case with issuing equity.