How does financial leverage affect firm risk?
A)Financial leverage increases the volatility of a firm's sales revenue.
B)Financial leverage increases the volatility of a firm's return on equity.
C)Financial leverage increases the volatility of a firm's EBIT.
D)Financial leverage increases the volatility of a firm's operating costs.

Question

Quizplus · Accepted Answer

Financial leverage refers to the use of debt to finance a company's operations. By using debt, the company can increase its return on equity (ROE) by earning a higher rate of return on the money it borrowed than the interest rate it is paying. However, this also increases the company's risk because if the company is not able to generate enough cash flow to service its debt, it may default on its obligations. This increases the volatility of the company's ROE, making it riskier for investors.

How Does Financial Leverage Affect Firm Risk