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

Question

Quizplus · Accepted Answer

The degree of financial leverage measures the sensitivity of a firm's earnings per share to changes in its earnings before interest and taxes (EBIT). If a firm has a higher proportion of debt and preferred stock in its capital structure, it will have a higher degree of financial leverage, and its earnings per share will be more sensitive to changes in EBIT. Conversely, if a firm has a lower proportion of debt and preferred stock, it will have a lower degree of financial leverage. Therefore, the correct answer is B, high.

A Firm That Employs a Relatively Large Proportion of Debt