Fundamentals of Financial Management, Third Edition

SUMMARY

The introduction of borrowed funds in the capital structure is known as financial leverage. One view is that the financial leverage does not influence the value of corporate wealth insofar as the shareholders indulge in an arbitrage process of selling and buying their shares on the one hand and, on the other, the cost of capital remains unaffected, although, in presence of taxes, leverage raises the value of the firm.

The other view is that leverage tends to lower the cost of capital and raises the eps, thereby, raising the value of the firm. Raising of the value of the firm through financial leverage does not mean that this process should go on indefinitely. After a specific point, leverage will raise the financial risk of the equity ...