Question

Discuss the effect of financial leverage on a firm

Answer 1

At an ideal level of financial leverage, a company's return on equity increases because the use of leverage increases stock volatility, increasing its level of risk which in turn increases returns. However, if a company is financially over-leveraged a decrease in return on equity could occur.

Financial leverage is the amount of debt that an entity uses to buy more assets. Leverage is employed to avoid using too much equity to fund operations. An excessive amount of financial leverage increases the risk of failure, since it becomes more difficult to repay

Answer 2

Explanation:

"Financial leverage means usage of long- term Debt in company’s capital structure.

These fixed cost capital which are employed for the capital structures includes debentures, loans and preference share capital.

EPS (Earning per share) is affected by the fluctuation in the earning of the company before taxes and interest (EBIT).

Financial Leverage degree variates the EPS of the shareholders.. In short if there is increase in EBIT the firm will increase the EPS.

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