1. U^ng financial leverage results in a fixed charge that can materially affect
ID: 2578501 • Letter: 1
Question
1. U^ng financial leverage results in a fixed charge that can materially affect earnings available to common shareholders a. b. increases risk to the firm as interest rates rise and returns to shareholders decreases c. may be favorable when earnings generated by use of borrowed funds exceeds borrowving costs d. reires reviewing planned business transactions for the potential impact they may have on operating income and the ability to cover fixed interest charges. All of the above answers are correct. e.Explanation / Answer
e) All of the above answers are correct.
financial leverage states the portion of fixed cost in the capital structure (cost of capital).
option A - financial leverage shows the portion of fixed charges in it's financing activity. so if company have a fixed operating expense (normaly interest) that will reduce the profit of the company and also the return to the shareholders.
option b- if company have a higher financial leverage, it means that company going under a big risk. fixed expenses are expenses which should pay regardless of companie's perfomance. whether company have profit or loss they need to pay the fixed expense. so this increases the risk and could reduce the return to the shareholders.
option c- if company can able to generate morethan the fixed expense fod each period they can get better profit.so financial leverage may be favourable when earnings generated by the borrowed funds exceed borrowed costs.
option d- financial leverage is very important for company's perfomance and their risk appetate. so they must check the effect on the operating income and the ability to cover the fixed interest charges.
from above description we can find that every options are currect regarding the financial leverage.
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