Financial leverage


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what is leverage? its types, and break even analysis

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Financial leverage

  1. 1.     money used by a company, provided by the shareholders or by loans to provide money to pay for something the study of how money is managed and the actual process of acquiring needed funds. the management of large amounts of money, especially by governments or large companies
  2. 2. A firm’s use of assets & liabilities using fixed costs in an attempt to rise potential returns to shareholders use of assets consuming fixed costs. The use of fixed operating costs by the firm. use of liabilities & preferred stock consuming fixed costs. The use of fixed financing costs by the firm. The British expression is gearing.
  3. 3.  Costs of sales  General admin, & selling expenses  interest charges  Preferred dividends  Income taxes  Costs that change in close relationship to variations in sales are named as variable costs. changes in total in proportion to changes in the related level of volume. on a per-unit basis variable cost remain constant.
  4. 4. Cost is a resource sacrificed or forgone achieve specific objective.  is the cost incurred (a historical cost)  as distinguished from budgeted costs.  a cost that has occurred  persist unchanged in total irrespective of changes in the related level of volume. with the level of production it change inversely .
  5. 5.  Can be identified specifically with a particular final cost objective i.e., a particular award, service or direct activity  Incurred for common or joint objectives and cannot be readily identified with a particular final cost objective  Cannot be easily identifiable.
  6. 6. Direct Variable Fixed Indirect
  7. 7.  The percentage change in a firm’s operating profit (EBIT) resulting formal present change in output (sales).
  8. 8.  Calculating the DOL for a single product or a singleproduct firm. Q (P - V) Q (P - V) - FC
  9. 9. =
  10. 10. The percentage change in a firm’s earnings per share (EPS) resulting from a 1 present change in operating profit.
  11. 11. . EBIT I PD t = Earnings before interest and taxes = Interest = Preferred dividends = Corporate tax rate
  12. 12. EBIT + FC DTL S dollars of sales DTL Q units = EBIT - I - [ PD / (1 - t) ] = Q (P - V) Q (P - V) - FC - I - [ PD / (1 - t) ]
  13. 13. determine the level of sales a firm must achieve to stay in business in the long run  Shows the mix of fixed and variable cost and the volume required for zero profit/loss  Profit/loss generally measured by EBIT (operating profit/loss) 
  14. 14. Using an algebraic calculation as a formula for earnings before interest and taxes yields:  EBIT = (P x Q) – FC – (VC x Q)  EBIT = Q x (P – VC) – FC  Setting EBIT equal to $0 and solving for Q (the firm’s breakeven point) yields: 
  15. 15. Every sale makes a ‘contribution’ per unit of the difference between price (P) and variable cost (V) Ct = P – V  Can be expressed as a percentage of the price  Known as the contribution margin (CM) CM = (P – V) / P 
  16. 16. cost Variable cost Fixed cost Over head Admin cost Wages premises Raw material Labour components
  17. 17. Break-even point = Fixed costs Selling price (per unit) – variable cost (per unit)
  18. 18.  EBIT-EPS Break-Even Analysis -- Analysis of the effect of financing alternatives on earnings per share. The break-even point is the EBIT level where EPS is the same for two (or more) alternatives. EPS (EBIT - I) (1 - t) - Pref. Div. # of Common Shares
  19. 19.  Leverage results from the usage of fixed costs to expand returns to firm’s owners. the mixture of debt and equity, affects leverage and value of firm. to measure total operating costs & level of sales Breakeven analysis is necessary