Financial leverage would NOT be increased if a firm financed its next project with: A) common stock. B) preferred stock. C) bonds with embedded call options. That is all information provided with the question. Unless the firm is currently UN-leveraged, I don’t think any of the above answer make sense? Or does anyone have a better explanation than: The correct answer was A) common stock. Financial leverage is the result of financing assets with fixed income securities such as bonds or preferred stock. Each of these alternatives has a required payment component that increases the risk of the firm beyond that arising solely from business risk.
I dont see what the issue is, the answer is clearly correct if the firm takes on preferred stock or debt it is commiting to make a payment, it is becoming levered, things go good, great ROE is multiplied, things go bad…the shit will multiply… on the other hand if it takes on more stock, it would become less levered… say it had 1$ debt, 1$ stock, well if it took on 1 more in stock, the effect of debt becomes less…
Sorry, didn’t know what come in to me. I saw it asking Financial leverage would NOT be !!changed!! if a firm financed its next project with: Haha, but it was increase… Thx for clear that up.