When EBIT is positive, increasing ﬁnancial leverage increases the sensitivity of EPS and ROE to
changes in EBIT.

Question

Quizplus · Accepted Answer

When EBIT is positive, increasing financial leverage increases the amount of interest expense, which reduces net income and EPS. However, if EBIT increases, the effect of the increased interest expense on EPS and ROE will be magnified as a result of the higher financial leverage. Therefore, EPS and ROE will become more sensitive to changes in EBIT with increasing financial leverage.

When EBIT Is Positive, Increasing ﬁNancial Leverage Increases the Sensitivity