Asked by Lindsay Stavnes on Jun 22, 2024
Verified
Financial leverage is beneficial when the company earns more than the incremental after-tax cost of debt.
Financial Leverage
The use of borrowed funds with a fixed cost in order to increase the potential return to shareholders.
Incremental
Relating to or denoting an increase or addition, especially one of a series on a fixed scale.
After-tax Cost
The cost of financing or an expense after accounting for the effects of income tax, often used to compare the true costs of financing options.
- Grasp the benefits and risks of financial leverage for a company.
Verified Answer
SP
shubham pardeshiJun 28, 2024
Final Answer :
True
Explanation :
Financial leverage refers to using debt financing to increase the potential returns for shareholders. It can be beneficial when the returns generated from the use of debt are greater than the cost of servicing the debt. This means that if a company earns more than the incremental after-tax cost of debt, financial leverage can be a useful tool to increase shareholder returns. In this case, the use of debt financing would be considered a good decision. However, if the returns generated from the use of debt are less than the cost of servicing the debt, then financial leverage can be detrimental to a company's financial stability.
Learning Objectives
- Grasp the benefits and risks of financial leverage for a company.
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