Question

Using financial leverage: All of the following are correct except:

a.	results in a fixed charge that may materially affect earnings available to common shareholders.
b.	increases risk to the firm as interest rates rise and returns to shareholders decrease.
c.	may be favorable when earnings generated by use of borrowed funds exceeds borrowing costs.
d.	requires reviewing planned business transactions for the potential impact they may have on operating income and the ability to cover fixed interest charges.
e.	all of the above are correct.

Answer 1

using financial leverage means using debt capital as a part of capital structure.

option a is correct because the company is obliged to pay interest on debt capital whether or not it earns the profit. so, it is a fixed charge on the company which affects the earnings available to common shareholders.

option b is correct because financial leverage increases the risk to the firm as interest being a fixed charge on the firm's income shall lead to decrease in returns to shareholders.

option c is correct because if the firm is able to earn from debt capital more than what it needs to pay for debt capital, then it would eventually increase available to common shareholders.

option d is correct because the firm must review their planned transaction so as to know whether they will be able to cover fixed interest charges from their income.

Hence, the correct answer is e. all of the above are correct.