We use the term leverage to describe the use of debt in the firm' capital structure because:

Question

Quizplus · Accepted Answer

Leverage refers to the use of debt to finance a firm's operations and investments, which can magnify the potential expected return to equity holders. However, it also increases the variability of that expected return, making it riskier. Therefore, option A correctly describes the use of leverage in a firm's capital structure. Option B is partially true, as leverage does increase the risk of bankruptcy for a firm. Option C is incorrect, as leverage does not necessarily magnify earnings per share.

We Use the Term Leverage to Describe the Use of Debt