Final answer:
Leverage is the technique of using borrowed capital to increase the potential return of an investment. It allows a firm to augment its investment capacity and potentially earn higher profits, but also increases financial risk. Firms can leverage funds through various means like bank loans or issuing bonds.
Step-by-step explanation:
The technique that defines raising the amount of return on an investment through capital borrowed from external sources is known as leverage. When a firm uses leverage, it borrows funds to finance its investments with the aim of increasing its potential returns. This can be done through bank loans, bonds, or other forms of debt. The principal advantage of leveraging is that it enables a company to make larger investments than its available capital would otherwise allow, which can result in higher profits. However, leverage also comes with higher risk, as the borrowed capital must be repaid with interest, and the firm may face financial difficulties if its investments do not yield the expected returns.
Firms choose among different sources of financial capital based on their specific needs and circumstances. These sources include obtaining funds through early-stage investors, reinvesting profits, borrowing through banks or bonds, and selling stock. Each of these methods has its own set of advantages and disadvantages. For instance, borrowing imposes scheduled payment obligations but keeps control with the firm's owners, while selling stock dilutes ownership but provides funds without the requirement of scheduled repayments.