Ignoring taxes,financial leverage affects the performance of a firm by
A)increasing the volatility of the firm's EBI.
B)decreasing the volatility of the firm's EBI.
C)decreasing the volatility of the firm's net income.
D)increasing the volatility of the firm's EPS.
E)lowering the firm's level of risk.

Question

Quizplus · Accepted Answer

Financial leverage increases the volatility of a firm's EPS (earnings per share) as it is calculated by dividing the firm's net income by the number of outstanding shares. When a firm uses debt financing, it incurs interest expenses that are deducted from its net income, thereby reducing the earnings available to shareholders. As a result, any increase or decrease in EBIT (earnings before interest and taxes) has a magnified effect on EPS, leading to higher volatility.

Ignoring Taxes,financial Leverage Affects the Performance of a Firm by