Arizona State University (ASU) ACC232 Financial Accounting I Exam 2 Practice

High financial leverage occurs when a company uses a significant amount of debt to finance its operations. This strategy can lead to increased returns on equity if the company performs well because the profits are spread over a smaller equity base. However, it also introduces a higher level of risk.

When a company is highly leveraged, its obligation to make regular interest payments can become burdensome during periods of poor performance or economic downturns. This means that while financial leverage can amplify gains when things go well, it can also magnify losses. Consequently, investors may face greater volatility in earnings and potential for loss, indicating the coexistence of increased risk and the potential for higher returns. Thus, the outcome of high financial leverage reflects both the elevated risk and the opportunity for enhanced returns, making it a pivotal feature in financial analysis.