LEVERAGE PPT.ppt

7/28/2019 LEVERAGE PPT.ppt

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Leverage & CapitalStructure

Prepared By:-

PANKAJ PREET SINGHMBA 2-D

ROLL NO:-15423


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Leverage

A firm is said to be leveraged ifit has fixed costs.

There are two types of

leverage: Operating leverage fixed costs

associated with running the firm.

Financial leverage fixed costs

associated with financing the firm. Degree of leverage

Measure of how much leverage the

firm uses.


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Capital Structure

The mix of long-term financialsources used to finance thefirm.

It usually refers to the specificproportions of debt, equity,preferred stock, etc. used tofinance the firm.

Only long-term sources areincluded.


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Breakeven Analysis

Finding the level of operationsnecessary to cover all costs.

Can also be used to analyze the

level of profitability associatedwith differing levels of sales.

Operating breakeven point:

The level of sales necessary tocover all operating costs:

The points where EBIT = $0.


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A Stylized Approach

The algebra:

PQ-VQ-F=EBIT

(P-V)Q-F=EBIT

Solving for Q when EBIT = $0:

Q=F/(P-V)

Practical problem:

Most companies dont sell only oneproduct/service, and thereforequantity is not as reliable as sales

volume.


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Operating Leverage

Operating leverage is the use offixed operating costs to magnifythe effects of changes in sales

to the firms operating earnings. Operating leverage is

particularly useful if the firm can

substitute variable for fixedcosts.


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Measuring Op. Leverage

Degree of Operating Leverage:

SalesinChange%

EBITinChange%DOL


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Financial Leverage

Financial leverage is the use offixed financial costs to magnifythe effects of changes in sales

to the firms net earnings.

Sources of financial leverage are

primarily debt and preferred stock.


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Measuring Fin. Leverage

Degree of Financial Leverage:

EBITinChange%

EarningsNetinChange%DFL


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Composite Leverage

Composite leverage is the use ofany fixed costs to magnify theeffect of changes in sales on the

firms net earnings. The two components of total

leverage are operating and

financial leverage. Categorizing two components

depend on where on the incomestatement the fixed cost is found.


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Measuring CompositeLeverage

Degree of Total Leverage:

SalesinChange%

EarningsNetinChange%DTL


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The Effect of Leverage on

Profitability

How does leverage affect the EPS and ROE of a firm?

When we increase the amount of debt financing,

we increase the fixed interest expense If we have a good year (BEP > kd), then we pay

our fixed interest cost and we have more left overfor our stockholders

If we have a bad year (BEP < kd), we still have

to pay our fixed interest costs and we have lessleft over for our stockholders

Leverage amplifies the variation in both EPS andROE

LEVERAGE PPT.ppt

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