Question

David is trying to decide whether to add capital through investing more of his own money or through borrowing money from the bank. to help him decide, you remind him that ss long as his firm's rate of return on its assets is greater than the cost of the debt, his rate of return on equity will _____ as the firm uses more debt.

Answer 1

The return of equity will increase. Businesses can finance themselves with debt and equity capital. By aggregating the quantity of debt capital kin to its equity capital, a company can increase its return on equity. The way in which rising financial leverage increases ROE is a little less instinctive. One way to think about it is that if a business adds debt, its assets increase for the reason that its cash inflows from the debt issuance and so does its entire debt.