Question

Financial leverage is called favorable if ____________.

• A. return on investment is lower than cost of debt
• B. return on investment is higher than cost of debt
• C. debt is nearly available
• D. the degree of existing financial leverage is low

Answer 1

Answer: (B)

return on investment is higher than cost of debt

Firstly, debt is considered a more effective source of positive financial leverage than preferred stock because the interest on debt is tax deductible but dividend on preferred stock is not.

Secondly, financial leverage is desirable when rate or return on investment using these amounts of money have been obtained from bank loan is more than the bank interests or dividend payable.