What are the likely results as the level of gearing rises?
A) Risk of financial distress decreases; cost of capital rises
B) Risk of financial distress increases; cost of capital falls
C) Risk of financial distress decreases; cost of capital falls
D) Risk of financial distress increases; cost of capital rises

Question

Quizplus · Accepted Answer

As the level of gearing (also known as leverage) rises, the risk of financial distress increases due to the higher amount of debt the company has taken on. This results in a higher cost of capital as investors demand a higher return to compensate for the increased risk. Therefore, the best answer is D - "Risk of financial distress increases; cost of capital rises."

What Are the Likely Results as the Level of Gearing