What effect does debt have on the equity investment's return?

When evaluating the impact of debt on the return of an equity investment, leveraging is a key concept. Positive leverage occurs when the return on the investment exceeds the cost of the debt. When this happens, using borrowed funds can amplify the returns to equityholders because the investment generates more income than the interest expense associated with the debt.

For example, if a business takes on debt at a lower interest rate than the return it earns on the investment, the excess return contributes to greater profit margins for equity investors. This is why debt can be a powerful tool for enhancing returns, provided that the additional risk associated with leveraging is managed effectively.

In contrast, other options suggest different scenarios about the relationship between debt and returns. However, in cases of positive leverage, the overall effect of debt is to potentially increase returns rather than reduce them or render them negligible. Therefore, understanding the dynamics of borrowing costs relative to investment performance is crucial for assessing how debt influences equity investment returns.