Final answer:
A higher capital ratio, when only equity is considered capital, results in a lower degree of financial leverage and a lower leverage measure, reflecting less dependence on debt and a more conservative financial strategy.
Step-by-step explanation:
The correct option is B:
When only equity counts as capital, the higher the capital ratio, the lower the degree of financial leverage.The capital ratio is a measure of financial stability and represents the proportion of equity to total assets. A higher capital ratio indicates a larger equity base relative to the debt. Financial leverage, on the other hand, refers to the use of borrowed funds to increase the potential return of an investment. The capital ratio is calculated by dividing equity by total assets. When the capital ratio is higher, it means that a larger proportion of assets are financed by equity rather than debt. This leads to a lower degree of financial leverage, as there is less reliance on borrowed money.
At the same time, the leverage measure, which indicates the amount of debt in relation to equity, increases as the equity portion remains the same while total assets increase. When a business has a higher proportion of equity in its capital structure, it is less dependent on borrowed funds, therefore, it has a lower degree of financial leverage. This also means that the leverage measure, which quantifies the extent of borrowing, is lower. In summary, a higher equity capital ratio leads to a reduced reliance on debt financing, reflecting a conservative financial strategy with less risk associated with high leverage.