Future Business Leaders of America (FBLA) Agribusiness Practice Test

How is leverage best defined in financial terms?

1. The measure of return on investment

2. A measure of the extent to which debt is being combined with equity capital

3. The total value of an asset

4. The ratio of profits to expenses

The correct answer is: A measure of the extent to which debt is being combined with equity capital

Leverage in financial terms specifically refers to the use of debt to acquire additional assets. It represents the ratio of debt that a company uses in relation to its equity capital. This concept is important because it illustrates how much a company is relying on borrowed funds to increase its asset base and potential returns. By utilizing leverage effectively, a business can enhance its returns on investment; however, it also increases the risk, as it must be able to meet interest payments and other obligations associated with that debt. In contrast, other options describe different financial concepts. The measure of return on investment is concerned with profitability and the effectiveness of an investment, while the total value of an asset speaks to its market value without considering how that value was financed. The ratio of profits to expenses indicates a company's efficiency in managing costs relative to its income, but does not directly address how leverage functions regarding debt and equity. Understanding leverage is crucial for evaluating a business's financial health and strategy in managing its capital structure.