Question

When a firm's degree of financial leverage increases, _____________________. Multiple Choice the probability that the firm will encounter financial distress increases the amount of the firm's total debt decreases the less debt the firm has per dollar of total assets the firm's number of outstanding shares of stock increases the firm's accounts payable balance decreases

Answer 1

Answer:

When a firm's degree of financial leverage increases, the probability that the firm will encounter financial distress increases.

Explanation:

The degree of financial leverage (DFL) is a leverage ratio that determines how sensitive a company's earnings per share are to changes in operational income when there are capital structure changes. The implication of this ratio is that higher the degree of financial leverage, the more variable the earnings of the company becomes.

The degree of financial leverage is largely used by the management to boost earnings per share and return-on-equity. But despite these advantages, the firm has to bear the cost of increasing profits volatility and the probability for a rise in the cost of financial distress, including bankruptcy.

Therefore, when a firm's degree of financial leverage increases, the probability that the firm will encounter financial distress increases.