Certified Management Accountant Practice Exam 2025 - Free CMA Practice Questions and Study Guide

Financial leverage refers specifically to the use of borrowed funds to increase the potential return on investment. By utilizing debt, a company can invest more capital into its operations, intending to achieve greater profits than it could through equity alone. When a company employs financial leverage, it amplifies both the potential gains and the risks, since it must repay the borrowed funds regardless of its financial success.

The choice that correctly defines financial leverage emphasizes its core principle—using borrowed funds to finance investments, which can lead to enhanced returns but also entails significant risk if the investments do not yield the expected results. This strategic approach is widely used in finance because it can help businesses grow more rapidly than they could purely through equity financing.

Other concepts that were presented, while related to corporate finance, do not accurately represent financial leverage. The use of equity to finance operations pertains to equity financing rather than leveraging borrowed funds. Investing in high-risk assets is a separate investment strategy that may involve leverage but does not encompass its definition. The practice of minimizing costs focuses on operational efficiency and cost management rather than the funding strategy defined by financial leverage.