The Concept of Financial Leverage Explained

:moneybag:Financial leverage involves using borrowed money to achieve goals.

:chart_with_upwards_trend:The goal of financial leverage is to generate higher returns than the cost of debt.

:balance_scale:The use of leverage comes with risk, as excessive debt can lead to financial distress.

:money_with_wings:Equity financing does not require interest payments, but dividends are not tax-deductible.

:tax:Interest payments on debt are tax-deductible, making it an attractive financing option from a tax perspective.

What is financial leverage?

—Financial leverage refers to using borrowed money to finance asset purchases or projects, with the expectation of generating a higher return than the cost of debt.

What is the risk of financial leverage?

—The risk of financial leverage is that excessive debt can lead to financial distress if the returns from the assets or projects do not meet the interest payments.

What is the difference between financial leverage and equity financing?

—Financial leverage involves borrowing money and paying interest, while equity financing involves asking shareholders to contribute funds, with dividends being optional.

Why is interest on debt tax-deductible?

—Interest on debt is tax-deductible because it is considered a business expense.

What factors should be considered when deciding between debt and equity financing?

—Factors to consider include the cost of debt, the riskiness of the project or asset, and the desired level of control over the company.

00:00Financial leverage involves using borrowed money to achieve goals.

01:42Excessive debt can lead to financial distress.

03:41Interest on debt is tax-deductible, making it an attractive financing option from a tax perspective.