Question

Explain how the following factor affects the choice of capital structure of a company:

Return on Investment

Answer 1

1. More debt in the capital structure is advantageous if a company's return on investment (ROI) exceeds the cost of debt since it will increase shareholder returns through financial leverage.
2. If ROI is low, however, an over-reliance on debt may result in financial strain and decreased profitability, which would force the business to choose equity over debt in order to preserve its financial stability.