As the financial leverage of a company increases, it leads to:

The correct answer is option 1- A decline in the cost of funds but an increase in the financial risk.

As the financial leverage of a company increases, it leads to the decline in the cost of funds but an increase in the 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.