Increasing a firm's financial leverage also increases ____.
A) the return on equity
B) EBIT
C) the amount of equity
D) the amount of dividends

Question

Quizplus · Accepted Answer

Increasing a firm's financial leverage (debt) also increases the amount of financial risk taken on by the firm. This in turn increases the required rate of return for the investors, including shareholders. As a result, the return on equity (ROE) will also increase, since it measures the return that shareholders receive on their investment in the firm. However, this also means that the firm will be more vulnerable to financial downturns, as it will have higher fixed costs to service its debts.

Increasing a Firm's Financial Leverage Also Increases ____