Question

Management may feel pressure to maintain debt covenants _______.

1) if a client is relying heavily on debt financing and struggling to make debt payments
2) if a client is relying heavily on equity financing and struggling to make equity payments
3) both the liquidity and solvency positions have improved
4) the accounts receivable turnover ratio has increased

Answer 1

Management may feel pressure to maintain debt covenants if a client is relying heavily on debt financing and struggling to make debt payments.

Step-by-step explanation:

In these scenarios, management may feel pressure to maintain debt covenants if a client is relying heavily on debt financing and struggling to make debt payments. When a client is struggling with debt payments, management may face consequences such as penalties or restrictions if they fail to meet the debt covenants. This pressure may force management to take necessary actions to ensure the client meets the debt obligations and avoids defaulting.

This is critical to avoid technical defaults which can exacerbate the firm's financial struggles. Debt financing requires regular interest payments, in contrast to equity financing, which does not obligate the firm to make such payments but can influence control over the company.

Management may feel pressure to maintain debt covenants if a client is relying heavily on debt financing and struggling to make debt payments. This pressure arises because failing to maintain debt covenants can lead to a technical default, which could have severe consequences — including the potential for accelerated debt repayment demands or increased interest rates. Firms accessing financial capital may either borrow through loans or bonds, committing to scheduled interest payments, or issue stock, diluting their ownership but avoiding regular interest payments. Knowing the implications of financial decisions is crucial for maintaining a firm's financial stability and growth potential.