Question

what is meant by the terms "favorable" and "unfavorable" leverage? given examples

Answer 1

• Financial leverage is favorable when a person borrows some amount but   returns generated are  greater than the interest paid . For example, if a company borrows Rs. 100 at 10% interest p.a., and earns a return of 12%, the leverage will be considered favourable.
• Thus he would earn a profit of Rs. 2 after paying the base amount as well as the interest.
• Unfavourable or negative leverage occurs when the firm does not earn less amount as compared to the interest paid for the loan.
• Unfavorable leverage occurs when the firm does not earn as the funds cost. This causes  a low level of profitability and also it makes borrowings more costly.
• For example, if a company borrows Rs. 100 at 10% interest p.a., and earns a return of 12%, the leverage will be considered favourable. Unfavourable or negative leverage occurs when the firm does not earn as much as the cost of debt.