A firm increases its financial leverage when its ROA is greater than the cost of debt. Everything else equal, this change will probably increase the firm's:
I. Beta
II. Earnings variability over the business cycle
III. ROE
IV. Stock price
A) I and II only
B) III and IV only
C) I, III, and IV only
D) I, II, and III only

Question

Quizplus · Accepted Answer

Increasing financial leverage when ROA is greater than the cost of debt will likely increase the firm's beta (reflecting higher risk), earnings variability (due to fixed interest payments on the debt), and ROE (since more debt financing can amplify returns on equity). However, the impact on stock price is not directly implied by these factors alone, as stock prices are influenced by a wide range of variables.

A Firm Increases Its Financial Leverage When Its ROA Is