Through the effects of financial leverage, when EBIT increases, earnings per share will
A) increase.
B) decrease.
C) remain unchanged.
D) change in an undetermined direction.

Question

Quizplus · Accepted Answer

Financial leverage refers to the use of borrowed funds (debt) to finance investments. By using debt, a company can amplify the potential return on investments. However, this also increases the risk of losses since the company has to pay interest on the debt even if earnings decline.

When a company has financial leverage, an increase in earnings before interest and taxes (EBIT) results in a bigger increase in earnings per share (EPS) due to the interest expense on debt remaining the same. Therefore, the answer is A) increase.

Through the Effects of Financial Leverage, When EBIT Increases, Earnings