Which of the following statements concerning a firm's degree of financial leverage (DFL) is correct? Assume everything else is equal.
A)If the firm issues additional common stock, its DFL should increase.
B)Compared to a lower DFL, a higher DFL implies a greater financial risk.
C)Compared to a higher DFL, a lower DFL implies a greater financial risk.
D)If the firm issues additional long-term debt, its DFL should decrease.
E)The firm's DFL cannot be negative.

Question

Which of the following statements concerning a firm's degree of financial leverage (DFL) is correct? Assume everything else is equal. 
A)If the firm issues additional common stock, its DFL should increase.
B)Compared to a lower DFL, a higher DFL implies a greater financial risk.
C)Compared to a higher DFL, a lower DFL implies a greater financial risk.
D)If the firm issues additional long-term debt, its DFL should decrease.
E)The firm's DFL cannot be negative.

Quizplus · Accepted Answer

A higher degree of financial leverage means that the company has more fixed financial costs in the form of interest payments, which increases its financial risk. Therefore, option B is the correct choice. Option A is incorrect because issuing additional common stock will not affect the level of fixed financial costs and therefore has no impact on the DFL. Option C is incorrect because a lower DFL means that the company has fewer fixed financial costs and therefore has a lower financial risk. Option D is incorrect because issuing additional long-term debt will increase the fixed financial costs and therefore increase the DFL. Option E is incorrect because a negative DFL is possible if the company's operating income is negative.

Which of the Following Statements Concerning a Firm's Degree of Financial