Question

Which of the following companies has the lowest degree of leverage?

90% Debt, 10% Equity
30% Debt, 70% Equity
20% Debt, 80% Equity
50% Debt, 50% Equity

Answer 1

Answer:

20% Debt,80% Equity is the lowest degrees of leverage

Answer 2

Answer:

20% Debt, 80% Equity has the lowest degree of leverage.

Explanation:

• Financial leverage refers to proportion of debt in overall capital.

• with the increase of debt fund the earning would increase because debt is a cheaper source of finance.  
• More debt will result in increase in earning only when rate of earrings of the company .i.e. return on investment should be more than rate of interest on debt.
• If rate of interest is more than the earnings or ROI of the company then more debt means loss for the company.

• more debt will result in increasing earring i.e. RETURN ON INVESTMENT > RATE OF DEBT.
• Generally companies use the concept of financial leverage capital structure.
• Capital structure means the proportion of debt and equity used for financing the operations of business.  
• In other words, it represents the ratio of debt capital to equity capital
• " what kind of capital is best for the firm is very difficult to determine?"

Thus, among the four cases, 20% Debt, 80% Equity has the lowest degree of leverage because of low percentage of debt in the capital structure.

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