Impact of Leverage on Total Payments to Security Holders

The firms earning stream, EBIT is unaffected by leverage. Incresing of

leverage can be attributed entirely to tax savings resulting from the tax
deductibility of interest payments. The increase in total payments to security
holders is a key advantage flowing from the use of debt capital.

The Cost of Funds

As leverage increases both both bondholders and shareholders are subjected
to increased risk. The risk includes risk of bankruptcy and risk of increased
variability in annual returns. These assumptions reflect a fundamental trade off
betwee risk and return. The required return on firms debt is the cost of debt
capital ad the required return on the firms equity is the cost of equity capital