Which of the following is correct?
A)The variation in ROE and EPS for an unleveraged firm is identical to variation in EBIT.
B)In a leveraged firm, the variation in ROE and EPS is always greater than the variation in EBIT.
C)Financial risk is the additional variation in ROE and EPS arising from the use of debt.
D)All of the above

Question

Quizplus · Accepted Answer

All of the given options are correct. 
Option A is true because without the use of debt, the equity owners have no fixed obligation to pay interest or principal which means that the variation in earnings is solely due to the variation in operating earnings or EBIT.
Option B is also true because when a firm uses debt, interest must be paid, so it increases the fixed obligations. This means that a change in EBIT also results in a greater change in the equity earning measures such as ROE and EPS.
Option C is also true because financial risk refers to the potential increase in the variability of earnings due to the increased fixed obligations associated with the use of debt.

Which of the Following Is Correct