Final answer:
The claim that financial leverage always increases EPS due to a reduction in shares outstanding is false. Financial leverage can increase EPS if the company's returns exceed the interest costs but also adds risk and does not inherently reduce the number of shares.
Step-by-step explanation:
The statement that increasing financial leverage will always lead to higher Earnings Per Share (EPS) because it reduces the number of shares outstanding is false. Financial leverage refers to the use of debt to acquire additional assets. It is important to understand that while financial leverage can potentially increase EPS, it does not in itself reduce the number of shares outstanding; instead, it involves taking on more debt. If a company is profitable, the use of debt can amplify the returns to equity shareholders, leading to a higher EPS. However, if the company's returns on the new investments are less than the interest rate on the new debt, the increased debt can reduce EPS. Furthermore, higher financial leverage also means increased risk, as the company must make interest payments regardless of its earnings, which can strain finances if earnings are variable or decline.
Moreover, there are scenarios where financial leverage can involve repurchasing shares, which could effectively reduce shares outstanding and potentially increase EPS, but this is not a direct result of leverage itself; rather, it's a use of leveraged capital for a specific purpose.