How does a company's capital structure affect its overall financial risk and cost of capital?

A company's capital structure, which consists of the mix of debt and equity financing it uses to fund its operations and growth, has a profound impact on its overall financial risk and cost of capital. This relationship is central to financial decision-making and corporate strategy. Let's explore how capital structure influences these key financial aspects: 1. Financial Risk: - Leverage Risk: One of the most significant ways capital structure affects a company's financial risk is through leverage. When a company uses debt financing, it incurs interest payments and must repay principal amounts at specified intervals. If the company is unable to meet these obligations, it can face financial distress, which may lead to bankruptcy. Therefore, higher debt levels generally result in higher financial risk. - Interest Coverage Ratio: The interest coverage ratio (ICR), calculated as earnings before interest and taxes (EBIT) divided by interest expense, measures a company's ability to meet its interest obligations. A higher ICR indicates lower f....