Why are leverage ratios important?
A) Low ROA can generate high ROE if the company is highly levered.
B) Leverage magnifies losses which increases risk.
C) Leverage ratios measure a firm's ROA.
D) High ROE can only be generated with high leverage.

Question

Quizplus · Accepted Answer

Leverage ratios are important because they measure a company's debt in relation to its assets, which can determine the level of risk for investors. High leverage can magnify losses and increase risk, while low leverage can provide a more stable financial position for the company. Therefore, B is the correct answer because it accurately describes the potential downside of high leverage. A, C, and D are incorrect because they either misunderstand the relationship between ROA and ROE (A and D) or incorrectly describe leverage ratios (C).

Why Are Leverage Ratios Important