Final answer:
The statement is false, as the impact of debt on a firm's profit margin depends on how the debt is managed and the returns generated from its use. Positive financial leverage occurs when firms use borrowed funds to earn a return greater than the cost of debt, potentially increasing their profit margins.
Step-by-step explanation:
The statement that the more debt a firm uses, the lower its profit margin will be is false. This is because the use of debt (leverage) can actually increase a firm's profit margin if the cost of debt is lower than the returns generated by the use of that debt. This condition is known as positive financial leverage.
However, it's important to recognize that while leverage can boost profit margins, it also increases financial risk, as interest payments become obligatory regardless of the firm's revenue performance.
For example, if a firm borrows money at a certain interest rate and invests it into projects that yield a higher rate of return, this can increase overall profits and thus profit margin. However, if the rate of return on investments is lower than the interest rate on debt, the profit margin can indeed be reduced.
Furthermore, companies may face increased financial burdens during downturns or when they have cash flow issues, which can negatively impact profit margins.
It is also crucial to understand that profit margin is a measure of profitability that reflects the percentage of revenue that remains as profit after all expenses are paid, including interest on debt.
Therefore, if debt is managed effectively and invested wisely, it can potentially increase the profit margin, contrary to the assumption that more debt always decreases profit margin.