High Lev Inc. borrows heavily and uses the leverage to boost its return on equit

Question

High Lev Inc. borrows heavily and uses the leverage to boost its return on equity to 30%, nearly 10% higher than the industry average. However, HighLev'sstock price decreases relative to its industry counterparts. How is this possible?

a. Markets are inefficient and fail to recognize the benefits of leverage.

b. The increase debt results in interest payments that made HighLev's operating income drop even though return on equity increased.

c. Shareholders are not interested in return on equity.

d. The high levels of debt increases the riskiness of HighLerv are relative to its competitors.

Explanation / Answer

d. The high levels of debt increases the riskiness of HighLerv are relative to its competitors.

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