Cost of Bankruptcy: Debt carries with it a commitment of future cash flows in the form of borrowing and periodic interest which increases the potential risk of business insolvency and bankruptcy. (Ebaid, 2009). Modgliani and Miller in their analysis had shown that a company can reduce the cost of capital by increasing the financial leverage in its capital structure. However, considerable use of debt financing would expose firms to high probabilities of default (Khan and Jain, 2005). Not only that, businesses will also find it challenging to meet the promised principles and interests. Furthermore, the company is likely to incur costs and suffer penalties if it is unable to pay interest and principles on time. This could result in legal fees, disruptions to operations and likely loss of profitable investment opportunities. As the proportion of debt in the capital structure increases, the likelihood of incurring these costs also increases. Therefore, redundant use of debt can lead to an increase in the cost of capital due to financial risk which in turn can reduce the value of the firm. This risk resulting from excessive use of debt is known as bankruptcy. Undoubtedly, the optimal capital structure is not the one with the maximum debt, but the one with the desired amount of debt, determined at a point where the overall cost of capital is minimum. Modgliani and Miller in their studies have shown that extreme debt increases financial risk along with the cost of capital. They advised firms to adopt a “target debt-to-GDP ratio” so as not to violate debt limits imposed by creditors (Khan and Jain, 2005). The advice implies that there is a safe limit for debt use beyond which debt should not be used. The point also indicates a very good… middle of the paper… a lack of financial flexibility: Maintaining financial flexibility is a big concern for creditors. Creditors are aware that a choice made today may limit their chances of making another choice in the future (Vernimmen, 2005). Therefore, debt incurred today adds pressure on future investments. In the future, suppose a major investment is needed and lending capacity is exhausted, then there would be a need to generate new equity capital. Therefore, the loss of flexibility can be disastrous if funds are needed and access to capital is blocked (Damodaran, 2012). Therefore it is very important to maintain high financial reserves when a company has many investment opportunities. “It can therefore be said that a strong increase in debt reduces the financial flexibility of the company, while a capital increase increases its debt capacity” (Vernimmen, 2005, p..686).