Question

Critically discuss how financial leverage can impact investors’ return on equity with regard to property investments under the market scenario with high inflation rate and high interest rate

60 words max

Answer 1

High financial leverage means high amount of debt and low equity. Because of this low equity, the denmominator of RoE is very less increasing it to a high value. But, when interest rate and inflation are high, this means we have to pay a high amount of interest on the high debt which increases the risk of the investment because if the returns (profits before interest) are not as high as expected, the high interest component can convert the profit after taxes into losses. Hence, leverage amplifies our returns in both good times and bad.