Which of the following scenarios indicates an effective use of financial leverage?
Which of the following scenarios indicates an effective use of financial leverage?
An effective use of financial leverage means that the use of borrowed funds (debt) contributes positively to the firm's return on equity. Option A indicates that the organization has a rate of return on equity (ROE) of 20%, which is higher than the rate of return on assets (ROA) of 15%. This suggests that the use of leverage (debt) has enhanced the returns to equity holders, which is a hallmark of effective financial leverage. Options B, C, and D do not directly address the relationship between ROE and ROA or the positive impact of debt on equity returns.
I think C is the correct one. When we say Financial Leverage, it refers to the borrowing of capital by a corporation from lenders, such as banks, to fund its operations and long-term investments in fixed assets (PP&E). Seems like C is the only choice that might relate to the definition. Any other thoughts?
Why not A?