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Options
-
Leverage improves ROE when business conditions are favorable
Correct answer
- B
In tough times, highly leveraged firms might perform better than those with low leverage
- C
High leverage can boost ROE since less equity is needed by the company
- D
High leverage can lower the ROE because of high interest costs
Why this is the answer
Financial leverage involves using debt to finance a company’s operations. When business conditions are favorable, the return on assets exceeds the cost of debt, amplifying Return on Equity (ROE). However, during unfavorable conditions, high leverage increases interest obligations and risk, potentially lowering ROE. While leverage can reduce equity needs, it carries significant financial risk, making A the correct statement in favorable conditions.
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