The increase in risk to equity holders when financial leverage is introduced is evidenced by:
A)higher EPS as EBIT increases.
B)increased use of homemade leverage.
C)a higher variability of EPS with debt than all equity.
D)equivalence value between levered and unlevered firms in the presence of taxes.
E)None of the above.

Question

Quizplus · Accepted Answer

When financial leverage is introduced, the variability of EPS increases due to the fixed interest payments on the debt. This means that the equity holders are exposed to more risk because any fluctuations in EBIT will have a larger impact on their earnings. The other options do not necessarily indicate the increase in risk to equity holders specifically.

The Increase in Risk to Equity Holders When Financial Leverage