The third lever of ROE, financial leverage, is a measure of how much debt the company carries. The way in which raising financial leverage increases ROE is a little less intuitive. One way to think about it is that if a company adds debt, its assets increase (because of the cash inflows from the debt issuance) and so does its total debt. Since equity is equal to assets minus total debt, a company can decrease its equity as a percentage of its assets by increasing its debt. In other words, assets--the numerator of the financial-leverage figure--increases, so the overall financial-leverage number rises, boosting ROE.
The Risks of Debt-Driven Returns on Equity >>