Why are leverage ratios important in overall financial analysis of a firm?
A)Low ROA can generate high ROE if the company is highly levered.
B)Use of leverage magnifies losses which increases risk.
C)Leverage ratios measure a firm's ROA.
D)High ROE can only be generated with high leverage.

Question

Quizplus · Accepted Answer

Leverage ratios are important in financial analysis because they measure the level of debt a company has taken on. While leverage can enhance returns in good times, it can also magnify losses in bad times and increase risk. Therefore, it is important to analyze a company's leverage ratios to understand its overall financial health and risk profile. Low ROA can generate high ROE if the company is highly levered, but this is not always a desirable outcome. Similarly, high ROE can be generated with high leverage, but this also increases risk and may not be sustainable in the long run. Leveraged ratios do not directly measure a firm's ROA.

Why Are Leverage Ratios Important in Overall Financial Analysis of a Firm