CFA Practice Question

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CFA Practice Question

What is the major advantage of debt financing?

A. Financial leverage
B. Interest expense is deductible in computing taxable income.
C. Fixed commitment to pay interest and principal
D. Little risk
Correct Answer: A

The major advantage of debt financing is that financial leverage can magnify shareholder returns.

User Contributed Comments 7

User Comment
jwp2 B is correct too. Without the tax advantage, the advantage of leverage is offset by the increased risk as reflected in the firm's cost of capital.
xqpanda B is also orrect. But the questions asks about the "major" advantage.
Masterkang I think financial leverage in itself is no advantage - only if the return on asset is higher than the cost of debt. However, interest expense is always tax deductible, therefore, B seems to be more correct.
thekapila B is correct from company perspective. As that will offset company's income with tax benefit,. From an analyst perspective A is correct as that will evaluate company's future earning
kutta2102 Given the current crisis, I think the answer should be changed to B since leverage hardly seems like an advantage anymore!
assiduous I like B as well. BUT, when thinking about the question in the context of management, generally speaking, you would want to maximize shareholder return. Financial leverage is much more impactful in this regard.
ascruggs92 B is not the major advantage though, never have that mindset. An expense that is tax deductible is only advantageous if the expense is justifiable. If it is not, then you are just "spending to save." I have relatives that own a business and they always do this at year end if they owe money to the IRS, they buy something they can write off as a business expense to lower their tax bill. That's cool if it's something they need, but if not, does spending $1 to save $0.40 really make sense?
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