Question

What is Financial leverage? What happens to the cost and risk when financial leverage increases.

Answer 1

Answer:

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.

Explanation:

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Answer 2

Explanation:

The degree of financial leverage (DFL) is a leverage ratio that measures the sensitivity of a company's earnings per share to fluctuations in its operating income, as a result of changes in its capital structure. This ratio indicates that the higher the degree of financial leverage, the more volatile earnings will be.

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.