The effect of financial leverage on ROE depends on:

Question

BlackTom AI · Accepted Answer

The question asks: The effect of financial leverage on ROE depends on:

Option provided: the firm's financing strategy.

Analyzing the statement: ROE = Net income / Shareholder equity. Financial leverage affects ROE through the use of debt. Whether ROE increases or decreases with leverage depends on how debt costs compare with the return generated on assets (ROA) and on the overall financing mix. If the firm deploys debt in a way that earns a return on assets greater than the cost of debt and any additional equity costs, leverage can boost ROE; if debt is expensive or the firm has low asset returns, leverage can reduce ROE. This link is fundamentally tied to the firm’s financing strategy, i.e., how much debt versus equity is used, what debt terms are, and how the capital structure interacts with profitability and risk.

Since the statement explicitly mentions the dependence on financing strategy, it captures the core idea that the impact of leverage on ROE is not fixed but contingent on how financing is arranged and managed.

Even when considering the broader theoretical backdrop, this dependence on the structure of financing (debt level, cost of debt, tax considerations, and asset returns) is consistent with standard financial theory: leverage amplifies returns (and losses) contingent on cost versus return.

Note: The provided data shows an answer field with a single option and an empty set of answer options. This means there are no other listed alternatives to compare. Without additional options, we cannot evaluate why other choices might be incorrect, but the reasoning above explains why the stated option is conceptually sound.

BUSI_V 370 922 2025SS Quiz 7: Capital Structure and Dividend Policy

The effect of financial leverage on ROE depends on:

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