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Question
As the financial leverage of a company increases, it leads to:
Options
A decline in the cost of funds but an increase in the financial risk
An increase in the cost of funds but a decline in the financial risk
Both an increase in the cost of funds and financial risk
Both a decline in the cost of funds and financial risk
MCQ
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Solution
A decline in the cost of funds but an increase in the financial risk
Explanation:
- When a company uses more debt (increasing financial leverage), it pays a lower cost of funds because debt is cheaper than equity.
- However, higher debt increases the company’s fixed obligations (interest payments), so the financial risk also increases.
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