HighLev Incorporated borrows heavily and uses the leverage to boost its return on equity to 30% this year,nearly 10% higher than the industry average.However,HighLev's stock price decreases relative to its industry counterparts.How is this possible?
A)Markets are inefficient and fail to recognize the benefits of leverage.
B)The increased debt resulted in interest payments that made HighLev's operating income drop even though return on equity increased.
C)Shareholders are not interested in return on equity.
D)the high levels of debt increased the riskiness of HighLev relative to its competitors.

Question

Quizplus · Accepted Answer

The fact that HighLev's stock price decreased relative to its industry counterparts suggests that investors perceived increased riskiness associated with the company's heavy borrowing. High levels of debt increase a company's financial risk, which can result in lower stock prices even if the return on equity improves. Therefore, option D is the best answer. Options A and C are not plausible explanations, as markets are generally efficient, and return on equity is an important metric that shareholders consider. Option B is also not the best answer as it contradicts the fact that return on equity increased.

HighLev Incorporated Borrows Heavily and Uses the Leverage to Boost