As long as a firm's rate of return is greater than the cost of the debt (interest rate) the owner's rate of return on equity will _____ as the firm uses more debt.
A) decrease
B) increase
C) remain the same
D) fluctuate

Question

Quizplus · Accepted Answer

This is because using debt allows the firm to increase its leverage, which amplifies the return on equity. If the rate of return on assets is greater than the cost of debt, then using more debt will increase the rate of return on equity. However, it is important to note that as the firm takes on more debt, the risk of default also increases, which could ultimately decrease the rate of return on equity in the long term.

As Long as a Firm's Rate of Return Is Greater