A firm that employs a relatively large proportion of debt in its capital structure will have a relatively ____ degree of financial leverage.
A)low
B)high
C)insignificant
D)constant

Question

Quizplus · Accepted Answer

A firm that employs a relatively large proportion of debt in its capital structure will have a relatively high degree of financial leverage. This is because debt amplifies both profits and losses. When a company earns more than the cost of servicing its debt, its shareholders receive a higher return. But when the company earns less than the cost of servicing its debt, its shareholders receive a lower return, or even lose money if there is default. Therefore, a high degree of financial leverage increases the risk and volatility of a firm's financial performance.

A Firm That Employs a Relatively Large Proportion of Debt