Why is EBIT generally considered to be independent of financial leverage? Why might EBIT be influenced by financial leverage at high debt levels?

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Why is EBIT generally considered to be independent of financial leverage? Why might EBIT be influenced by financial leverage at high debt levels?

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Why is EBIT generally considered to be independent of financial leverage? Why might EBIT be influenced by financial leverage at high debt levels?

Explanation & AnswerSolution by a verified expert

Explanation

The earnings before interest and taxes (EBIT) is determined after subtracting operating costs from the sales revenue. Since the cost of financial leverage is the interest cost, which is deducted once the EBIT is computed; therefore, it (financial leverage) does not have any impact on the EBIT of a company.
 
However, when excessive leverage is used then sales and operating costs are affected by financial leverage and hence, EBIT is affected at a high debt level because high debt means more operating costs, therefore EBIT will be reduced.

Verified Answer

Financial leverage does not affect the earnings before interest and taxes (EBIT) as EBIT depends on sales and operating costs and the interest cost is then deducted from the company's EBIT.
 
Financial leverage can affect EBIT when excessive leverage is used as a high debt level affects sales and operating costs which affects EBIT.

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