UGC NET COMMERCE January 2017(Paper-II) Q32
- Option : B
- Explanation : Financial Leverage and the Shareholders’ Return : The primary motive of a company in using financial leverage is to magnify the shareholders’ return under favourable economic conditions. The role of financial leverage in magnifying the return of the shareholders is based on the assumptions that the fixed-charges funds (such as the loan from financial institutions and banks or debentures) can be obtained at a cost lower than the firm’s rate of return on net assets (RONA or ROI). Thus, when the difference between the earnings generated by assets financed by the fixedcharges funds and costs of these funds is distributed to the shareholders, the earnings per share (EPS) or return on equity (ROE) increases. However, EPS or ROE will fall if the company obtains the fixed-charges funds at a cost higher than the rate of return on the firm’s assets. It should, therefore, be clear that EPS, ROE and ROI are the important figures for analyzing the impact of financial leverage.
