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Financial leverage refers to the use of fixed-cost sources of finance, particularly debt and preference share capital, in the capital structure of a firm. It arises because a firm uses funds on which it has to pay fixed financial charges, such as interest on loans and debentures, irrespective of its level of operating profit. Financial leverage is an important concept in financial management because it affects the relationship between operating profit and earnings available to equity shareholders. The degree of financial leverage indicates how sensitive earnings per share (EPS) are to changes in operating profit. The basic principle of financial leverage is that borrowed funds can magnify the returns available to equity shareholders when the firm earns a return on its investments greater than the cost of debt. For example, if a company borrows money at an interest rate of 8% and _____ ___ ___ _________ _____ _______ ___ __________.
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