MANAGEMENT

Detailed explanation-1: -The leverage effect describes the effect of debt on the return on equity: Additional debt can increase the return on equity for the owner. This applies as long as the total return on the project is higher than the cost of additional debt.

Detailed explanation-2: -Positive leverage is when a business or individual borrows funds and then invests the funds at an interest rate higher than the rate at which they were borrowed. If the loan constant is greater than the cap rate, it is positive leverage. If it is lower than the cap rate, it is negative leverage.

Detailed explanation-3: -The study shows that when leverage increases, investors demand a higher return to compensate them for the added financial risk. The results make economic sense because shareholders are expected to demand higher returns to compensate them for the additional financial risk.

Detailed explanation-4: -A company’s return on equity increases at an optimum level of financial leverage because the use of leverage increases the stock volatility, increasing the level of risk which then increases the returns. Financially over-leveraged companies may face a decrease in return on equity.

Detailed explanation-5: -Although high debt levels are touted to be shareholder-friendly, highly levered companies do not deliver higher returns.