The effect of financial leverage depends on the operating earnings of the company.Which of the following is not true?
A)Below the indifference or break-even point in EBIT the non-levered structure is superior.
B)Financial leverage increases the slope of the EPS line.
C)Above the indifference or break-even point the increase in EPS for all equity plans is less than debt-equity plans.
D)Above the indifference or break-even point the increase in EPS for all equity plans is greater than debt-equity plans.
E)The rate of return on operating assets is unaffected by leverage.

Question

Quizplus · Accepted Answer

This statement is not true because above the indifference or break-even point, the increase in EPS for all equity plans is actually less than the increase in EPS for debt-equity plans. Financial leverage magnifies the earnings per share when earnings are positive, but also magnifies the losses when earnings are negative. Therefore, the increase in EPS will be lower for all equity plans compared to debt-equity plans when earnings are high enough to offset the fixed interest charges associated with debt financing.

The Effect of Financial Leverage Depends on the Operating Earnings