Higher debt – equity ratio results in:

Lower financial risk Higher degree of operating risk Higher degree of financial risk Higher EPS.

Higher degree of financial risk

The proportion of debt in the overall capital is also called financial leverage. Financial leverage is computed as D/E or D/(D+E) when D is the Debt and E is the Equity. As the financial leverage increases, the cost of funds declines because of increased use of cheaper debt but the financial risk increases.