Why is financial leverage significant for companies?

Financial leverage is significant for companies because it involves the use of borrowed funds to invest in opportunities that can generate a higher return than the cost of the debt. By employing financial leverage, a company can increase its potential returns on equity. When a company borrows money and invests it wisely, the gains from the investment can exceed the interest expenses associated with the debt. This amplification effect allows businesses to grow faster and potentially enhance shareholder value.

In scenarios where a company's investment generates high returns, the profits attributable to equity holders can be significantly higher due to the leverage effect. This concept is fundamental in corporate finance, as it enables companies to expand their operations, invest in new projects, or improve their capital structure without having to raise equity capital, which may dilute existing shareholders' ownership.