Gearing increases earnings per share when the return on assets exceeds the:

Question

Quizplus · Accepted Answer

Gearing or financial leverage involves using borrowed funds to finance investments with the expectation of earning a higher return than the cost of borrowing. The after-tax cost of debt is usually lower than the return on assets (ROA), so using debt to finance investments can increase the ROA and earnings per share. However, if the firm's return on shareholders' equity (ROE) is lower than the ROA, then using debt can lower the ROE and increase financial risk. Dividends paid and return on sales are not relevant in determining the impact of gearing on earnings per share.

Gearing Increases Earnings Per Share When the Return on Assets