Accounting: What the Numbers Mean 9th Edition by Wayne W McManus, Daniel F Viele, David H Marshall

Exercise 89

Financial leverage A firm issues long-term debt with an effective interest rate of 10%, and the proceeds of this debt issue can be invested to earn an ROI of 12%. What effect will this financial leverage have on the firm’s ROE relative to having the same amount of funds invested by the owners?

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Financial leverage :

It is described as the degree to which a firm or investor is utilizing the borrowed money for the business.

Financial leverage ratios represent the company’s total borrowing for financing its assets. It evaluates the company’s dependability on debt financing. It is the ratio of total debt to shareholders equity.