Positive financial leverage occurs in which of the following situations?
A)Interest payments can be deducted for income tax purposes.
B)The company's after-tax return on total assets is less than the after-tax cost of borrowing.
C)The return to the owners is enhanced through the use of debt financing.
D)Payment of resources to creditors is limited to the required interest payments while the return of the principal borrowed is not required.

Question

Quizplus · Accepted Answer

Positive financial leverage occurs when the return to the owners is enhanced through the use of debt financing, meaning that the return on assets funded by debt is higher than the cost of the debt. This allows the company to achieve a higher return on equity than if it had only used equity financing. Option A is incorrect as tax deductibility of interest does not necessarily mean positive financial leverage. Option B is incorrect as it describes negative financial leverage. Option D is incorrect as it is describing an interest-only loan, which does not necessarily guarantee positive financial leverage.

Positive Financial Leverage Occurs in Which of the Following Situations