Unformatted text preview: age, the use of fixed financial costs to magnify returns. Leverage also increases risk. This chapter
will show that financial leverage and capital structure are closely related concepts that can minimize the cost of capital and maximize owners’ wealth. I 507 508 PART 4 LG1 LG2 Long-Term Financial Decisions 12.1 Leverage leverage
Results from the use of fixed-cost
assets or funds to magnify
returns to the firm’s owners.
The mix of long-term debt and
equity maintained by the firm. Leverage results from the use of fixed-cost assets or funds to magnify returns to
the firm’s owners. Generally, increases in leverage result in increased return and
risk, whereas decreases in leverage result in decreased return and risk. The
amount of leverage in the firm’s capital structure—the mix of long-term debt and
equity maintained by the firm—can significantly affect its value by affecting
return and risk. Unlike some causes of risk, management has almost complete
control over the risk introduced through the use of leverage. Because of its effect
on value, the financial manager must understand how to measure and evaluat...
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