Question

Which relationship produces Unfavourable Financial Leverage and a decrease in EPS as debt increases?

Options

• RoI < Cost of Debt

• RoI > Cost of Debt

• EPS increases as debt increases

• Cost of funds declines due to increased use of cheaper debt

Answer 1

Unfavourable Financial Leverage occurs when RoI is less than the Cost of Debt. Under this relationship, EPS decreases as debt increases and Trading on Equity is inadvisable.