LEVERAGE-PPT.ppt
- 1. LEVERAGES
- 2. Capital Structure and Leverage Leverage analysis is the technique, which is used to quantify risk return relationship of different alternatives of capital structure
- 3. Risk Business Risk vs. Financial Risk Risk exists because of lack of certainty. Business risk depends on business factors such as competition, product liability, and operating leverage. Financial risk depends only on the types of securities issued: More debt, more financial risk.
- 4. LEVERAGE The use of various financial instruments or borrowed capital, such as margin, to increase the potential return of an investment. The amount of debt used to finance a firm's assets. A firm with significantly more debt than equity is considered to be highly leveraged.
- 5. CAPITAL STRUCTURE DECISION PROCESS CAPITAL BUDGETING DECISION NEED TO RAISE FUND CAPITAL STRUCTURE DECISION DESIRED DEBT-EQUITY MIX EXISTING CAPITAL STRUCTURE PAYOUT POLICY EFFECT OF RETURN EFFECT OF RISK EFFECT ON COST OF CAPITAL VALUE OF THE FIRM OPTIMUM CAPITAL STRUCTURE Replacement Modernisation Expansion Diversification Internal funds Debt External equity
- 6. TYPES OF LEVERAGE OPERATING LEVERAGE: It arises out of fixed operating costs FINANCIAL LEVERAGE: It arises out of fixed financial charges Combined Leverage
- 7. Operating Leverage Operating leverage is a measure of business risk It is defined as the firm’s ability to use fixed operating cost to magnify the effect of changes in sales on its EBIT. The OL of 1.5 means that 1% increase in sales would result in 1.5% in EBIT
- 8. MEASURE OF OPERATING LEVERAGE DEGREE OF OPERATING LEVERAGE (DOL) DOL = % CHANGE IN OPERATING PROFIT/ EBIT % CHANGE IN SALES VOLUME Alternatively, DOL = Q(S-V) Q(S-V)-F =CONTRIBUTION OPERATING PROFIT/ EBIT Where, Q= No. of units sold S= Unit selling price V=Unit variable cost F= Fixed cost for the period
- 9. ADVANTAGES OF DOL DOL is a measure of the firm’s business risk It helps in understanding the impact of change in sales on operating income of the firm It helps to make production planning proper
- 10. Financial Leverage FL is a measure of Financial risk It shows the impact of change in EBIT on EPS FL exists if there is use of funds bearing fixed financial payments The FL of 1.5 means that 1% increase in EBIT would result in 1.5% increase in EPS
- 11. MEASURE OF FINANCIAL LEVERAGE DEGREE OF FINANCIAL LEVERAGE (DFL) DFL = % CHANGE IN EPS % CHANGE IN EBIT = EBIT EBT = EBIT EBT - Dp / (1- t) Where, EBIT= Q(S-V)- F EBT=EBIT – Interest Dp =Preference Dividend t =Corporate tax rate
- 12. ADVANTAGES OF DFL Helps in designing appropriate capital structure of the firm Indicates market prices of the shares Enables understand how EPS would change given a certain change in EBIT
- 13. Combined Leverage It is a measure of total risk The percentage change in EPS occurring due to a given percentage change in sales It is product of OL and FL
- 14. MEASURE OF COMBINED LEVERAGE DCL = % CHANGE IN EPS % CHANGE IN Sales = Contribution EBT = Contribution EBT - Dp / (1- t) Where, EBT=EBIT – Interest Dp =Preference Dividend t =Corporate tax rate
- 15. Trading on Equity The use of the sources of funds with fixed cost, such as debt and preference shares capital along with the owner’s equity capital in the capital structure is known as trading on equity. EBIT –EPS Analysis: To examine the impact of leverage on the EPS. It shows the impact of various alternative financial plans on EPS at various levels of EBIT