Which statement is correct about the financial leverage of a company with an equity base of $400,000?
A)A company that borrows $150,000 is more leveraged than a company that borrows $250,000.
B)A company that borrows $250,000 is more leveraged than a company that borrows $150,000.
C)The return on equity of the company is unaffected by the financial leverage.
D)The return on equity of the company will be higher if it has a lower leverage.

Question

Quizplus · Accepted Answer

Financial leverage measures the extent to which a company relies on debt to fund its operations. The more debt a company has, the more leveraged it is. Therefore, a company that borrows $250,000 is more leveraged than a company that borrows $150,000, as it has a higher debt-to-equity ratio. The return on equity of the company is affected by financial leverage, as higher leverage can lead to higher returns but also higher risk. However, the statement does not provide enough information to determine whether the return on equity will be higher or lower with a lower leverage.

Which Statement Is Correct About the Financial Leverage of a Company