The correct answer is: C. Equity shareholders would demand higher return.
When a company increases its proportion of debt, it increases its financial risk. This is because debt financing is a form of leverage, which means that a small change in the company’s profits can lead to a large change in its earnings per share (EPS). As a result, equity shareholders will demand a higher return on their investment to compensate for the increased risk.
Option A is incorrect because interest payments on debt are tax-deductible. This means that the company’s tax bill will be lower if it finances its operations with debt.
Option B is incorrect because the P/E ratio is a measure of a company’s valuation, not its financial risk. The P/E ratio is calculated by dividing the company’s stock price by its earnings per share. A higher P/E ratio indicates that investors are willing to pay more for the company’s stock, which may be due to factors such as the company’s growth prospects or its competitive position.
Option D is incorrect because the rate of return of a company is not affected by its financial risk. The rate of return is a measure of the company’s profitability, and it is calculated by dividing the company’s net income by its assets. A higher rate of return indicates that the company is more profitable.