General Studies · Leverage and Returns
In the context of project finance evaluation, if the Project Internal Rate of Return (Project IRR) is greater than the cost of debt, how does increasing the level of debt (leverage) in the capital structure affect the Equity IRR?
Verified Solution4 OptionsUpdated: October 2026👁️1 View
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- 1It causes the Equity IRR to converge toward the Project IRR as debt becomes the dominant source of funding.
- 2It increases the Equity IRR because the project generates a higher return than the cost of the borrowed funds.✓
- 3It has no impact on the Equity IRR as the return on assets is independent of the financing structure.
- 4It decreases the Equity IRR because higher interest obligations increase the project's financial risk.
Correct answer
It increases the Equity IRR because the project generates a higher return than the cost of the borrowed funds.
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