Which of the following is true concerning the rate of return earned on shares of a levered firm in terms of the possible range of earnings? There are no taxes.
A) The returns do not differ from those of an unlevered firm.
B) The returns are greater than for an unlevered firm on the upside and equal on the downside.
C) The returns are the same as for an unlevered firm on the upside and lower on the downside.
D) The returns are greater than for an unlevered firm on the upside and lower on the downside.
E) The returns are the same as for an unlevered firm on the upside and greater on the downside.

Question

Quizplus · Accepted Answer

Leverage amplifies returns, making them higher than those of an unlevered firm when earnings are up (due to the fixed cost of debt magnifying earnings per share) and lower when earnings are down (as interest expenses must still be paid, reducing or negating earnings per share).

Which of the Following Is True Concerning the Rate of Return