A company will normally prefer to issue debt because it is cheaper and interest payments are tax deductible; what is a key condition for debt issuance?

• A. The company must have steady cash flow to make coupon payments.
• B. The company must have volatile cash flows
• C. The company should avoid tax shields
• D. The company should maximize equity price

Answer: (A)

Debt financing relies on fixed payment obligations like coupons and eventually principal. A company will normally issue debt only if it can reliably generate enough cash flow to cover those fixed payments. Steady, predictable cash flows reduce the risk of default and help preserve the firm’s credit quality, making debt cheaper on an ongoing basis due to lower interest costs and a favorable tax shield on interest.

Volatile cash flows make it harder to meet fixed payments, which raises default risk and either raises interest costs or limits the ability to issue new debt. The tax shield is a benefit of debt, not a requirement, and maximizing equity price is about equity financing considerations rather than a constraint that enables debt issuance.