Which scenario correctly illustrates the effect of high financial leverage on shareholders?

Financial leverage (using debt in capital structure) creates fixed interest costs. When a highly leveraged company earns profits above its interest cost, the entire surplus flows to equity holders — amplifying ROE beyond what an unleveraged firm would earn. Conversely, when earnings fall or losses occur, the fixed interest obligation remains, amplifying the downside for equity holders. A company with zero debt has zero financial leverage — no amplification in either direction. High leverage is therefore a double-edged sword: beneficial in good times, dangerous during downturns. Option D is wrong — equity holders bear residual losses and only receive value after all creditors (debt holders) are paid. Option E is wrong — leverage amplifies losses in bad times.