Which of the following is a consequence of high gearing?

• A. A broader base for profits due to leverage.
• B. High gearing increases the likelihood of higher shareholder dividends.
• C. It reduces the need to raise additional finance.
• D. It leads to higher risk of liquidation if interest payments cannot be met.

Answer: (D)

Gearing is about how much of a company’s funding comes from debt versus equity. When gearing is high, a large chunk of profits is consumed by fixed debt payments and interest. If the business slows or cash flow drops, those fixed obligations still have to be paid, increasing the risk of distress. If interest payments can’t be met, the company can run into serious trouble and may face liquidation or bankruptcy. That makes high gearing a clear risk factor—the consequence described is the elevated risk of liquidation due to inability to service debt.

Leverage can magnify profits when things go well, but it isn’t a guarantee of higher profits or dividends, and it doesn’t reduce the need to raise more finance; in fact, it often raises the pressure to maintain servicing of debt.