Financial leverage impacts the performance of the firm by:
A)maintaining the same level of volatility of the firm's EBIT.
B)decreasing the volatility of the firm's EBIT.
C)decreasing the volatility of the firm's net income.
D)increasing the volatility of the firm's net income.
E)None of the above.

Question

Quizplus · Accepted Answer

Financial leverage refers to the use of debt to finance a company's operations or investments. By using debt, a company can increase its return on equity (ROE) but at the same time, it also increases the volatility of the firm's net income. This is because interest payments to debt holders are fixed, and if the company's earnings before interest and taxes (EBIT) decreases, the interest payments would become a larger proportion of its earnings, causing its net income to fluctuate more dramatically. Therefore, financial leverage has the potential to increase the volatility of a firm's net income.

Financial Leverage Impacts the Performance of the Firm By