Limits To Debt Financing

This question tests your understanding of capital structure, the weighted average cost of capital, and the tradeoff between tax benefits and financial risk. In an investment banking interview, the key reasoning is that the cost of debt is not fixed, because as leverage rises lenders demand more compensation for higher default risk and the company may face tighter borrowing terms. Interviewers ask this to see whether you understand that financing decisions are not just about choosing the cheapest single source of capital, but about balancing tax shields, distress risk, and the flexibility constraints that come with debt covenants.