CFA Level 1 | g7hxvmf | Question Effect of Financial Leve...

Corporate Finance

Effect of Financial Leverage on Earnings

Very Easy Measures Of Leverage Financial Leverage

Consider a company with a capital structure that comprises both debt and equity. Financial leverage refers to the use of debt in a company's capital structure and how this can influence the company's earnings per share (EPS) in relation to changes in its operating income (EBIT).

Which of the following statements best describes the effect of financial leverage on a company's earnings?

Financial leverage increases the company's risk of insolvency but does not affect the potential return on equity.

Financial leverage magnifies both potential gains and potential losses, impacting earnings per share.

Financial leverage decreases the overall cost of capital irrespective of the company's operating performance.

Hint

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