Capital Structure Question:
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What does financial leverage indicate? What are its limitations?
Answer:
Financial leverage indicates borrow of funds to raise the capital by issuing shares in the market to meet their business requirements. This also indicates the profitability and return on equity of the company which has taken significant amounts of debt. The financial leverage has many advantages but it possess some limitations as well which has been shown as follows:-
1) When a company borrows funds using financial leverage then this money develops an environment that can either creates lots of profits or a small amount of it.
2) Borrowing constantly creates an image that the company might be on high risk. Which in turn increases the interest rates and some restrictions could be handed over to the borrowing organization.
3) Value of stock also gets affected as it can drop substantially if the stockholders intervene in between.
1) When a company borrows funds using financial leverage then this money develops an environment that can either creates lots of profits or a small amount of it.
2) Borrowing constantly creates an image that the company might be on high risk. Which in turn increases the interest rates and some restrictions could be handed over to the borrowing organization.
3) Value of stock also gets affected as it can drop substantially if the stockholders intervene in between.
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