Discuss the limitations of financial leverage.
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Discuss the limitations of financial leverage?
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Solution Summary
Three paragraphs and one reference given to assist you. Three limitation are discussed.
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The use of the fixed-charges sources of funds, such as debt and preference capital along with the owners' equity in the capital structure, is described as financial leverage or gearing or trading on equity.
The financial leverage employed by a company is intended to earn more return on the fixed-charge funds than their costs. The surplus (or deficit) will increase (or decrease) the return on the owners' equity. The rate of return on the owners' equity is levered above or below the rate of return on total assets.
The limitations are:
1)If the cost of borrowed funds is more than the return on equity than it will lead to reduction in profitability of the ...
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