An increase in the ﬁnancial leverage of a ﬁrm as a result of an increase in outstanding debt __________ the potential reward to stockholders while ___________ the risk of ﬁnancial distress
Or bankruptcy.
A) Decreases; decreasing
B) Increases; decreasing
C) Increases; increasing
D) Decreases; increasing
E) Does not affect; increasing

Question

Quizplus · Accepted Answer

An increase in financial leverage by taking on more debt can increase the potential rewards to stockholders due to the tax shield on interest payments and potential higher returns on equity. However, it also increases the risk of financial distress or bankruptcy due to the higher obligation to meet debt repayments.

An Increase in the ﬁNancial Leverage of a ﬁRm as a Result