Question
How does 'Risk Consideration' affect the Capital Structure Decision?

Answer

There are two types of risks in business:
  1. Operating Risk or Business Risk: This refers to the risk of inability to discharge permanent operating costs (e.g., rent of the building, payment of salary, insurance instalment, etc).
  2. Financial Risk: This refers to the risk of inability to pay fixed financial payments (e.g., payment of interest, preference dividend, return of the debt capital, etc.) as promised by the company. The total risk of business depends on both these types of risks. If the operating risk in business is less, the financial risk can be faced which means that more debt capital can be utilised. On the contrary, if the operating risk is high, the financial risk likely to be created after the greater use of debt capital, should be avoided.

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