Why might a company use financial leverage?

A company might use financial leverage primarily to potentially enhance investment returns. Financial leverage involves using borrowed funds or debt to finance the purchase of assets with the expectation that the income generated from those assets will exceed the cost of borrowing. When a company successfully employs financial leverage, it can amplify its earnings, as the profits from the investments made with the borrowed money can lead to higher returns on equity for shareholders. This can be especially beneficial in favorable market conditions, where the returns on investments outpace the interest costs associated with the debt.

Utilizing financial leverage is a strategic decision, as it can increase the potential for profitability, although it also raises the risk of losses if the investment does not perform well. The effectiveness of financial leverage depends on the company’s ability to manage its debt levels and ensure that it can service that debt even in downturns.

In contrast, the other options do not accurately reflect the typical motivations for employing financial leverage. Avoiding taxes is not a primary reason for using debt, as interest expenses can lead to tax deductions but this is not the sole benefit of financial leverage. Increasing operational costs runs contrary to the aim of financial leverage; companies seek to improve profits, not inflate costs. Lastly, financial leverage does not inherently decrease the number of outstanding