The cost of equity increases with increasing financial leverage in order to compensate the stockholders for the higher degree of financial risk.

Question

Quizplus · Accepted Answer

When a company uses financial leverage, it increases its debt level and therefore increases the financial risk for the stockholders. As a result, stockholders may require a higher rate of return (or cost of equity) to compensate for this higher risk.

The Cost of Equity Increases with Increasing Financial Leverage in Order