Final answer:
The correct answer is b, indicating that investors typically accept a lower risk-adjusted rate of return on debt capital because equity investments are generally riskier and have variable returns, whereas debt obligations have fixed claims.
Step-by-step explanation:
The correct answer is option b. Investors typically accept a lower risk-adjusted rate of return on debt capital than on equity capital because equity claims bear more risk than fixed claims on debt obligations. When an investor supplies financial capital through saving, they expect to receive a rate of return that compensates them for the investment risks taken. The expected rate of return incorporates future interest payments, capital gains, or increased profitability, and is usually measured as a percentage over a period of time.
Equity investments are associated with a higher level of risk compared to debt investments due to their subordination in the event of liquidation and the variability of returns. As such, investors demand a higher return to compensate for this increased risk. In contrast, debt instruments like bonds come with a fixed rate of return and are often perceived as lower risk since they are prioritized over equity in bankruptcy situations. Furthermore, the risk associated with a debt investment can be more accurately predicted and managed with tools such as credit ratings and interest rate hedges.