Debt is ______, but is more _______ for a business because the payment of interest and the return of principal is obligatory for the business.

The correct option is Cheaper, risky.

Here is the step-by-step explanation of why this is the correct choice:

1. Why is debt "Cheaper"?
From a business finance perspective, debt is generally a cheaper source of finance than equity for two main reasons:
• Tax Deductibility of Interest: In most tax jurisdictions, the interest payments made on debt are tax-deductible expenses. This reduces the business's taxable income, effectively lowering the net cost of debt. This is known as the tax shield benefit.
• Lower Risk for Investors: Debt holders (creditors/lenders) have a prior claim on the firm's assets and earnings over equity shareholders in the event of liquidation. Because debt is less risky for lenders compared to equity investments, lenders require a lower rate of return (interest rate) than the return demanded by equity investors (cost of equity).

2. Why is debt "more risky"?
Although debt is cheaper, it introduces significant financial risk to the business:
• Obligatory Payments: Unlike equity dividends, which are discretionary and paid out of profits, the payment of interest and the repayment of the principal amount are contractually binding legal obligations.
• Default and Bankruptcy Risk: The business must make these payments regardless of its financial performance or cash flow situation. If the business fails to meet these obligations, it faces default, which can lead to legal action, insolvency, or bankruptcy.

Therefore, debt is cheaper than equity, but it is more risky for a business due to the obligatory nature of interest and principal payments.