Fodder shortage and land degradation in the form of soil erosion and nutrient depletion remain the major constraints to agricultural productivity in the Ethiopian highlands. Forage legumes have the possibility to provide high quality and quantity of feed, to increase soil nitrogen, to accumulate an extra income to farmers, and to reduce soil erosion when they are intercropped with cereals; therefore intercropping legumes offer a ray of hope for small-scale, resource-poor farmers in developing countries. Despite these multiple benefits, few empirical studies have been done to advance evidences highlighting the effects of intercropping forage legumes with cereals on agricultural productivity and soil conservation. The forage legume-cereal intercropping system needs to be economically feasible and needs to meet the household food requirements in order to be adopted and sustained. In this study we attempt to fill this gap by assessing both the economic and the soil conservation implications of introducing legume-cereal intercropping in the mixed farming systems of the north-western Ethiopian highlands. Using a bio-economic linear programming model we generated an optimal farm which incorporated crop production jointly with livestock production, according the mixed farming system. The model combines household surveys with experimental data. The empirical results indicate that introducing forage legume- cereal intercropping into a traditional mixed farming model increases farm household income and resource productivity, and reduces soil erosion and pressure on grazing land. Farm income and resource productivity increase in the range of 52-75 percent and 10-14 percent, respectively. In addition, soil erosion and the marginal value productivity of grazing land decreases in the range of 8-9 percent and 65 percent, respectively. In a sensitivity analysis of alternative model scenarios farm income was higher and more stable for forage legume-cereal intercropping farming systems than with the traditional mixed farming model. In sum, results imply that development interventions realizing the economic and environmental potential of forage legumes will help achieve a double goal of enhancing the livelihoods of rural households and at the same time preventing land degradation.