Certified Management Accountant 2026 – 400 Free Practice Questions to Pass the Exam

When a company employs a high degree of financial leverage, it means that it is using a significant amount of debt financing relative to equity financing. This strategy increases the potential for higher returns on equity. The principle behind this effect is that when a firm borrows funds to invest in its projects, any earnings generated from those investments can lead to a higher return on the shareholders' equity after covering fixed interest expenses.

In a scenario where the firm's investments yield a return greater than the cost of debt, the excess earnings amplify the returns for equity holders. As a result, while financial leverage carries risks, the potential for greater returns is indeed one of its primary attractions.

Additionally, while high financial leverage can increase both potential returns and risks, it does not inherently lead to increased stability in cash flows, lower interest payments, or reduced market competitiveness. These factors are typically influenced by other operational and market dynamics rather than just the degree of leverage used.