The effect of financial leverage on ROE depends on:
A)the firm's financing strategy.
B)the dividend amount paid out.
C)the market value of the debt.
D)none of the above.

Question

Quizplus · Accepted Answer

Financial leverage refers to the use of debt financing to increase the potential return on equity. The effect of financial leverage on ROE will depend on the firm's financing strategy, which includes the amount of debt used and the interest rate paid on that debt. A higher degree of leverage can increase ROE when the return on the assets financed with debt is higher than the cost of that debt. However, too much leverage can also increase the risk of financial distress or bankruptcy, which can negatively impact ROE. The dividend amount paid out and the market value of debt do not directly affect the impact of financial leverage on ROE.

The Effect of Financial Leverage on ROE Depends On