Question

Companies have the opportunity to use varying amounts of different sources of financing, including internal and external sources, to acquire their assets, debt (borrowed) funds, and equity funds. Which of the following is considered a financially leveraged firm

a. A company that uses only equity to finance its assets
b. A company that uses debt to finance some of its assets

Answer 1

Answer: b. A company that uses debt to finance some of its assets

Explanation: Leverage refers to the use of debt (borrowed funds) to amplify returns with a contractually determined return to increase the ability of a business to invest and earn an expected higher return, but usually at high risk. As opposed to using equity, firms use debts to raise capital, invest in business operations etc. in an attempt to increase shareholder value. A firm that uses debt to finance some of its assets is referred to as a financially leveraged firm.