easy · Principles of Finance cost-of-capital-structure
If a firm increases its use of financial leverage (debt) while its operating income (EBIT) remains constant, what is the likely effect on the firm's Return on Equity (ROE)?
- ROE will decrease because interest expenses reduce the Net Income available to shareholders.
- ROE will decrease because higher debt always increases the firm's total risk.
- ROE will increase because the same operating income is spread over a smaller equity base.
- ROE will remain unchanged because EBIT is independent of the capital structure.
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