Certified Financial Management Specialist Practice Exam

What characterizes a company with a high leverage ratio?

1. More equity than debt

2. Higher reliance on debt to finance assets

3. Lower capital growth potential

4. Conservative financial structure

The correct answer is: Higher reliance on debt to finance assets

A company with a high leverage ratio is characterized by a higher reliance on debt to finance its assets. This means that the company uses a significant amount of borrowed funds in comparison to its equity to support its operations and growth. Financial leverage can be a double-edged sword; it can amplify returns when the business performs well, as the cost of borrowing (interest payments) may be outweighed by the gains from using that debt to enhance operations. However, it can also increase financial risk, as fixed obligations to repay debt remain regardless of the company’s performance. This focus on leveraging debt highlights the company's strategy in capital structure management, emphasizing the trade-off between risk and potential return. In contrast, options indicating more equity than debt or a conservative financial structure would typically represent lower leverage, while lesser capital growth potential is not inherently tied to high leverage but rather influenced by various operational factors.