Question

If the rate of earnings on investment for a company is 16%, a situation of unfavourable financial leverage will be said to arise when the rate of interest payable on debt capital is ______.

Options

• More than 16%

• Less than 16%

• Equal to 16%

• None of the above

Answer 1

If the rate of earnings on investment for a company is 16%, a situation of unfavourable financial leverage will be said to arise when the rate of interest payable on debt capital is more than 16%.

Explanation:

• When a company earns 16% on its investments but pays more than 16% on debt, the cost of debt is higher than the return.
• This results in a loss for shareholders, which is an unfavourable financial leverage situation.

If the interest rate is less than 16%, the company benefits, and the leverage is favourable.