What is the primary effect of financial gearing?
A) To ensure that shareholders' returns exceed the firm's income
B) To ensure that the firm's income closely reflects the shareholders' returns
C) To reduce the degree of variation in a firm's income for shareholders' returns
D) To magnify the impact of variation in a firm's income on shareholders' returns

Question

Quizplus · Accepted Answer

The primary effect of financial gearing is to magnify the impact of variation in a firm's income on shareholders' returns. This is because financial gearing involves the use of debt to fund a portion of a firm's operations. As a result, the firm's income can be amplified by the use of leverage, but this also means that any losses or declines in income will be magnified as well. This can lead to increased risk and volatility for shareholders.

What Is the Primary Effect of Financial Gearing