Leverage increases the volatility of a company’s earnings and cash flows and increases the risk of lending to or owning a company. Additionally, the valuation of a company and its equity is affected by the degree of leverage: The greater a company’s leverage, the greater its risk and, hence, the greater the discount rate that should be applied in its valuation. Further, highly leveraged (levered) companies have a greater chance of incurring significant losses during downturns, thus accelerating conditions that lead to financial distress and bankruptcy.
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