What effect does increasing leverage have on a company's risk profile?

Increasing leverage in a company's capital structure refers to the use of debt to finance operations or growth. This approach can amplify both returns and risks associated with the company's operations. When a company takes on more debt, it has an obligation to make interest payments, which can become a significant burden, especially during periods of economic downturn or when the company faces declining revenues.

As a result, while leverage can enhance returns on equity during prosperous times — as profits are distributed among fewer equity holders— it also introduces greater financial risk. If a company is unable to meet its debt obligations due to fluctuating cash flows, this can lead to financial distress or bankruptcy. Consequently, an increase in leverage can create greater volatility in earnings and cash flow, impacting the company's overall risk profile by making it more susceptible to market fluctuations and economic cycles.

The other options suggest effects that do not accurately reflect the relationship between leverage and risk. For instance, the idea that leverage lowers overall risk undermines the reality that increased debt raises the stakes for financial stability. Similarly, claiming leverage has no significant impact overlooks its crucial role in determining risk levels. Finally, suggesting that leverage provides immediate financial benefits ignores the long-term implications and potential pitfalls associated with high levels of debt. Thus, the assertion that increasing