Quiz on Financial Leverage and Governance

Financial leverage refers to:

• The use of equity financing in a firm's capital structure

• The use of debt financing to amplify returns to shareholders

• Reducing operational risk through diversification

• Reducing the company's assets to reduce liabilities

Financial leverage is measured using:

• Return on equity (ROE)

• Return on assets (ROA)

• Debt-to-equity ratio

• Net profit margin

A higher degree of financial leverage implies:

• Lower business risk

• Higher operational risk

• Greater risk of insolvency during poor economic times

• Lower debt in the capital structure

Which of the following formulas is used to calculate financial leverage?

• Total assets / Total equity

• EBIT / Interest expense

• Total debt / Total equity

• Total liabilities / Total assets

A company that has no debt in its capital structure has:

• High financial leverage

• Zero financial leverage

• Negative financial leverage

• Moderate financial leverage

Financial leverage magnifies:

• Operational efficiency

• Earnings before interest and taxes (EBIT)

• Profitability during downturns

• Returns to shareholders, both positive and negative

Which of the following is not an advantage of using financial leverage?

• Increases potential returns to shareholders

• Interest payments are tax-deductible

• Reduces financial risk

• Can help finance growth without issuing more equity

The degree of financial leverage (DFL) measures the sensitivity of:

• Earnings before interest and taxes (EBIT) to changes in sales

• Earnings per share (EPS) to changes in EBIT

• EBIT to changes in net income

• Return on assets (ROA) to changes in debt

Which of the following would lead to an increase in financial leverage?

• Issuing new shares of stock

• Retaining earnings instead of paying dividends

• Borrowing more through issuing bonds or loans

• Paying off long-term debt

A company with high financial leverage is likely to experience:

• Lower interest expenses

• Greater fluctuations in net income

• Less sensitivity to changes in revenue

• A higher equity-to-debt ratio