Financial Impact of Leverage on Firm's Cost Structure Quiz

Leverage in finance refers to the use of borrowed funds to increase the potential return on investment.

Financial risk refers to the possibility of a company failing to meet its debt obligations.

Financial leverage tends to increase a company's return on equity (ROE), assuming the return on assets (ROA) exceeds the cost of debt.

High financial leverage tends to amplify a company's earnings per share (EPS) during favorable economic conditions.

Operating leverage can enhance returns to shareholders by increasing the profitability of a company's operations.

Financial leverage can amplify returns to shareholders by magnifying the effects of successful investments.

Operating leverage measures how sensitive a company's profits are to changes in sales volume.

The degree of financial leverage is calculated by dividing a company's earnings before interest and taxes (EBIT) by its interest expense.

Operating leverage magnifies the effect of changes in sales on a company's profits, increasing profit variability.

High financial leverage raises the risk of bankruptcy due to the higher debt burden.

Financial leverage raises a company's weighted average cost of capital (WACC) due to the higher cost of debt.

Financial leverage increases the use of debt financing relative to equity financing in a company's capital structure.

The breakeven point in terms of operating leverage is where a company's revenue covers all its fixed costs.

The breakeven point indicates the sales volume needed for a company to cover all its costs and achieve a zero profit.

High operating leverage makes a company more sensitive to changes in sales volume, leading to greater swings in profits.

Operating leverage is highest in companies with high fixed costs and low variable costs.

Financial distress occurs when a company cannot meet its short-term financial obligations, potentially leading to bankruptcy.