IGNOU BCOE 143 2025 2026 - When does financial leverage become favourable? Discuss its impact on

Question

When does financial leverage become favourable? Discuss its impact on risk.

16 Nov 2025

Answer :

Word Count : 318

Financial leverage becomes favourable when the return on the firm’s assets exceeds the cost of debt. In other words, if a company can earn a higher rate of return on its investments than the interest it pays on borrowed funds, the use of debt amplifies the earnings available to equity shareholders. This occurs because debt has a fixed cost in the form of interest, and any excess return generated beyond this cost increases the residual income for shareholders. Financial leverage is measured by the proportion of debt in the capital structure, and its effect on profitability can be analyzed

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