How does the cost of equity change when firms increase their use of debt?

Answer 1

the volatility of returns to the shareholders increases. This is because a 1% change in sales will now cause a larger change in EPS than it used to.

[increased financial leverage causes this]

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higher volatility means higher required rate of return.

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it is the job of the CFO to figure out the optimal level of debt and thus keep the average cost of capital near the minimum, given the shareholders' desires and the business position of the company.


does this help?