Banking · Financial Leverage and Financial Metrics
In the context of infrastructure project finance, if a project's Internal Rate of Return (Project IRR) is higher than the interest rate charged on its senior debt, what is the most likely impact of increasing the debt-to-equity ratio on the Equity IRR?
Verified Solution4 OptionsUpdated: October 2026👁️1 View
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- 1The Equity IRR will become equal to the cost of debt due to the principle of no-arbitrage in efficient markets.
- 2The Equity IRR will remain constant as IRR is an intrinsic property of the project's cash flows.
- 3The Equity IRR will increase because of the positive effect of financial leverage on shareholder returns.✓
- 4The Equity IRR will decrease because the financial risk and debt service obligations increase.
Correct answer
The Equity IRR will increase because of the positive effect of financial leverage on shareholder returns.
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