The increase in risk to equity holders when financial leverage is introduced is evidenced by:
A) higher EPS as EBIT increases.
B) a higher variability of EPS with debt than all equity.
C) increased use of homemade leverage.
D) equivalence value between levered and unlevered firms in the presence of taxes.

Question

Quizplus · Accepted Answer

The introduction of financial leverage (debt) increases the risk to equity holders primarily because it leads to a higher variability of Earnings Per Share (EPS). This is because fixed interest payments on debt must be made regardless of the company's earnings, making the earnings available to equity holders (and thus EPS) more volatile.

The Increase in Risk to Equity Holders When Financial Leverage