BUSINESS ADMINISTRATION
FINANCIAL MANAGEMENT
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Question
[CLICK ON ANY CHOICE TO KNOW THE RIGHT ANSWER]
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Return on investment is lower than cost of debt
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Return on investment is higher than cost of debt
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Dept is nearly available
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If the degree of existing financial leverage is low
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Detailed explanation-1: -Financial Leverage refers to the proportion of debt in the overall capital. It is said to be a favourable situation when the return on investment becomes higher than the cost of debt.
Detailed explanation-2: -Financial leverage refers to proportion of debt in overall capital. It is said to be favorable situation when the return on investment becomes higher than cost of debt. ROI becomes greater, EPS also increases and financial leverage is said to be favorable.
Detailed explanation-3: -Thus, with an increase in financial leverage, the cost of equity increases. WACC (Weightage Average Cost of Capital) remains constant; and with the increase in debt, the cost of equity increases. An increase in debt in the capital structure results in increased risk for shareholders.
Detailed explanation-4: -Leverage can be favorable or unfavorable. It is positive when earnings are greater than debt costs. However, it is negative if the company’s earnings are lower than the cost of securing the funds. Debt financing is an essential source of capital to support the limited investment of stockholders.
Detailed explanation-5: -As the proportion of debt to assets increases, so too does the amount of financial leverage. Financial leverage is favorable when the uses to which debt can be put generate returns greater than the interest expense associated with the debt.