Question
Leverage means the amount of debt used to finance the firm assets. A firm with more debt than equity is called High Leverage firms. And
Leverage means the amount of debt used to finance the firm assets. A firm with more debt than equity is called High Leverage firms. And More equity than debt is called a low leverage firm. A firm that operates with both high operating and financial leverage makes for a risky investment. A high operating leverage means that a firm is making few sales but with high margins. This can pose significant risks if a firm incorrectly forecasts future sales. If a future sales forecast is slightly higher than what actually occurs, this could lead to a huge difference between actual and budgeted cash flow, which will greatly affect a firm's future operating ability. The biggest risk that arises from high financial leverage occurs when a company's ROA does not exceed the interest on the loan, which greatly diminishes a company's return on equity and profitability.
Step by Step Solution
There are 3 Steps involved in it
Step: 1
Get Instant Access to Expert-Tailored Solutions
See step-by-step solutions with expert insights and AI powered tools for academic success
Step: 2
Step: 3
Ace Your Homework with AI
Get the answers you need in no time with our AI-driven, step-by-step assistance
Get Started