Question

Why is the amount of debt in a company's capital structure important to the financial analyst?

1) Debt is less costly than equity.
2) Equity is riskier than debt.
3) Debt implies risk.
4) Debt is equal to total assets.

Answer 1

The amount of debt in a company's capital structure is important to a financial analyst because it affects cost, risk, and overall financial health.

Step-by-step explanation:

The amount of debt in a company's capital structure is important to a financial analyst for several reasons:

Debt is less costly than equity: When a company borrows money through debt, it usually pays lower interest rates compared to the returns shareholders expect from equity investments.

Equity is riskier than debt: Debt is considered less risky because it is backed by the company's assets, while equity represents ownership in the company and is subject to fluctuations in its value.

Debt implies risk: A high amount of debt in a company's capital structure indicates higher financial risk as it increases the company's leverage and interest expense.

Therefore, understanding the amount of debt a company has helps a financial analyst assess its financial risk and analyze the cost and structure of its capital.