Which one of these best supports the argument that leverage increases shareholder risk?
A)EPS is directly related to EBIT.
B)Individuals employ homemade leverage.
C)EPS variability increases when leverage is used.
D)Firm values rise with leverage in the presence of taxes.
E)The number of shares outstanding tends to decrease when leverage is used.

Question

Quizplus · Accepted Answer

EPS variability increases when leverage is used. When a firm uses debt to finance its operations, it creates fixed interest obligations that must be met regardless of the company's financial performance. As a result, the variability of earnings per share (EPS) increases. This increased volatility in EPS translates into increased risk for shareholders, making C the best option to support the argument that leverage increases shareholder risk.

Which One of These Best Supports the Argument That Leverage