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Financial leverage magnifies returns to equity because borrowing

  • A.has a variable cost while the return on assets is fixed
  • B.reduces the firm's total assets
  • C.always costs less than equity
  • D.has a fixed cost while the return on assets varies

Answer: D

Whatever the assets earn above the interest rate accrues entirely to the owners, and whatever they earn below it is borne entirely by them. The effect works in both directions, which is exactly what makes leverage risky.

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