How does financial gearing affect the extent to which shareholders' returns vary as a result of changes in a firm's income?
A) It has little effect on it.
B) It magnifies the effects.
C) It introduces a time lag.
D) It reduces the effects.

Question

Quizplus · Accepted Answer

Financial gearing, also known as leverage, refers to the use of debt financing in a company's capital structure. When a company has a high level of debt, its fixed interest payments can magnify the effect of changes in income on shareholders' returns. This is because changes in income have a larger impact on the company's profits, and therefore the return available to shareholders, when the company has a high level of debt. Conversely, when a company has a low level of debt, changes in income have less impact on shareholders' returns, as there are fewer fixed interest payments to be made.

How Does Financial Gearing Affect the Extent to Which Shareholders