General Studies · Capital Structure

Assertion: A firm that operates in a highly volatile industry with unstable cash flows should ideally maintain a low debt-to-equity ratio in its capital structure to ensure financial stability and minimize the risk of default. Reasoning: Because interest payments on debt are fixed legal obligations that must be met regardless of the firm's operating performance, high financial leverage combined with low operating stability increases the probability that the firm will be unable to cover its financial charges, leading to potential bankruptcy and higher costs of financial distress.