Which statement best describes the impact of a high debt-to-equity ratio?

Which statement best describes the impact of a high debt-to-equity ratio?

• A. Low liquidity
• B. High profitability due to leverage
• C. Greater financial risk due to leverage
• D. More equity financing than debt

Answer: (C)

A high debt-to-equity ratio signals more financial leverage, meaning the firm relies more on debt than on equity to finance its assets. Debt brings fixed obligations—interest and principal payments—that must be met from operating cash flow. If profits fall or cash flow is volatile, those fixed costs can be hard to cover, increasing the risk of financial distress or default. Leverage can magnify returns in good times, but it also magnifies losses, so the overall risk profile rises. The other statements don’t capture the primary impact: leverage doesn’t guarantee low liquidity, nor does it ensure higher profitability, and a high debt-to-equity ratio implies more debt, not more equity.

A high debt-to-equity ratio signals more financial leverage, meaning the firm relies more on debt than on equity to finance its assets. Debt brings fixed obligations—interest and principal payments—that must be met from operating cash flow. If profits fall or cash flow is volatile, those fixed costs can be hard to cover, increasing the risk of financial distress or default. Leverage can magnify returns in good times, but it also magnifies losses, so the overall risk profile rises. The other statements don’t capture the primary impact: leverage doesn’t guarantee low liquidity, nor does it ensure higher profitability, and a high debt-to-equity ratio implies more debt, not more equity.