Certified Management Accountant Practice Exam

Increasing a firm's financial leverage refers to the practice of using debt to finance a greater portion of the company's operations and investments. One key consequence of this strategy is that lenders may demand higher interest rates due to the increased risk perceived in lending to a more leveraged firm. When a company has more debt relative to its equity, it is seen as riskier, as it has higher obligations to fulfill in the form of interest payments. This elevated risk can lead to lenders requiring higher returns for the additional risk they are taking on, which manifests as higher interest rates on loans.

In contrast, options like lower cost of equity would not be a direct consequence of increased financial leverage, as equity investors typically expect higher returns for the increased risk associated with leverage. The idea that increased market share can be achieved without risks misrepresents the realities of leveraging, as increased debt heightens financial risk. Lastly, while asset sales can occur for various reasons, they are not a direct consequence of financial leverage; rather, increased leverage might lead a firm to reassess its asset base but wouldn't inherently result in a reduction of total assets. Thus, the concern over increased interest costs due to higher perceived risk is the most accurate representation of a consequence of raising financial leverage.