Which of the following statements about financial leverage is true?
A) Financial leverage is the responsiveness of the firm's EBIT to fluctuations in sales.
B) Financial leverage involves the incurrence of fixed operating costs in the firm's income stream.
C) Financial leverage is the responsiveness of the firm's EPS to fluctuations in EBIT.
D) Financial leverage reduces a firm's risk.

Question

Quizplus · Accepted Answer

Financial leverage is the degree to which a firm uses borrowed funds to finance its operations. It involves the use of fixed financial costs such as interest on debt, preferred stock dividends, etc. The use of financial leverage magnifies the variability of EPS (Earnings per share) with changes in earnings before interest and taxes (EBIT). Therefore, option C is a true statement. Option A is incorrect as it defines operating leverage. Option B is incorrect as it defines business risk. Option D is incorrect as financial leverage increases a firm's risk.

Which of the Following Statements About Financial Leverage Is True