What is the relationship between the Debt Ratio and financial leverage?

The correct choice demonstrates that a higher debt ratio is directly indicative of increased financial leverage. The debt ratio is calculated by dividing total liabilities by total assets, reflecting the proportion of assets that are financed through debt. Therefore, when a company's debt ratio increases, it means that a larger portion of its assets is being financed by borrowed funds rather than equity.

This reliance on debt financing magnifies the potential for returns on equity because debt can increase the overall capital available for investment. Consequently, as the debt ratio rises, so does the financial leverage—the extent to which a company uses debt to finance its operations. Financial leverage can amplify both gains and losses, making it an important metric in assessing a company's risk and potential return.

In contrast, a lower debt ratio would suggest that the company is financing more of its assets through equity, which would generally indicate lower financial leverage. Thus, the relationship is clear: a higher debt ratio corresponds to higher financial leverage, making the correct answer evident.