Question in regardsto FI 360.

Original Question and my answer:

Q12-2. What is the fundamental principle of financial leverage?

Answer:

Fundamental principle of financial leverage:

Substituting debt for equity increases expected returns to shareholders but also increases therisk that equity investors bear. (Graham, J. & Smart, S. (2012) Pg. 374)

The fundamental principle of financial leverage says that substituting debt for equity increases the expected returns to shareholders and the risk associated with those expected returns.

Additional question asked directly from my professor.

Why do utility companies often have such high financial leverage ratios?

My original thought would be becausethere are so many customers who owe money on their bills. The utility company would have to have a high financialleverage in awaiting the payment from customers.

I am not sure if that is even close. However, I would like to have a better explanationthan two simple sentences but I can not think of anything else to include.

So my question is:Why do utility companies often have such high financial leverage ratios?

Thanks!