Accounts & Finance

"(a) The value of a firm does not always increase with the level of debt. In fact, there is an optimal capital structure that maximizes a firm's value, and it depends on various factors such as the cost of debt, cost of equity, and the firm's financial risk profile.

While debt can provide tax advantages and amplify returns for shareholders when the firm is performing well, it also introduces financial risk. Higher debt levels increase the firm's financial obligations, including interest payments and principal repayments, which can be burdensome if the firm's cash flows are insufficient to meet these obligations. Excessive debt can lead to financial distress and bankruptcy, resulting in a decrease in firm value."