Question

Explain leverage and why it is important?

Answer 1

Leverage is an investment strategy of using borrowed money - to finance an investment . It is a technique involving using debt rather than fresh equity in making an investment .

It is a common practice . It is mostly used to increase the returns on equity capital of a company , especially when the business is unable to increase its operating efficiency & returns on total investment . Because earning on borrowing is higher than interest payable on debt , the company's total earnings will increase ,ultimately boosting the earnings of stockholders . It provides a variety of financing sources by which the firm can achieve its target earnings . It can act as a very good alternative for business when the return on additional investment is lower than cost of debt .