Leverage

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Leverage

  1. 1. Leverage Anupama
  2. 2. Capital Structure <ul><li>Various means of financing represent financial structure of the firm. </li></ul><ul><li>It includes liabilities + equity </li></ul><ul><li>Traditionally short term borrowings are excluded from the list of methods of financing capital exp. and hence all long term claims are a part of capital structure. </li></ul>
  3. 3. Types of Leverage <ul><li>Three types </li></ul><ul><li>Operating Leverage. </li></ul><ul><li>Financial Leverage. </li></ul><ul><li>Combined Leverage </li></ul>
  4. 4. Operating Leverage <ul><li>Effect of change in sales on EBIT of the company </li></ul><ul><li>DOL indicates – small change in level of sales will produce large change in Operating income </li></ul><ul><li>It’s a measure of firms business risk- variability in EBIT </li></ul><ul><li>DOL=( % change in EBIT)/ (% change in sales or output) </li></ul><ul><li>or {Q(S-V)}/ {Q(S-V)-F) </li></ul>
  5. 5. Operating Leverage Contd.. <ul><li>DOL at Operating break even point, where EBIT is zero is undefined. </li></ul><ul><li>Units at Break even point can be cal. Using formula Q= Total Fixed cost/(S-V)p.u </li></ul><ul><li>Different levels of output has different DOLs </li></ul><ul><li>It’s a measure of Firms business risk </li></ul>
  6. 7. Financial Leverage <ul><li>Measures effect of change in EBIT on EPS </li></ul><ul><li>Also refers to mix of debt and equity in capital structure of the firm. </li></ul><ul><li>Double edged sword. </li></ul><ul><li>DFL = (% change in EPS)/(% change in EBIT) </li></ul><ul><ul><li>Or DFL= EBIT/ {EBIT-I- [Pref Div/(1-t)]} </li></ul></ul>
  7. 8. Financial Leverage Contd… <ul><li>DFL is undefined at Financial Break Even point. </li></ul><ul><li>EBIT= I+{Pref Div./(1-t)} gives us the point of Fin Break Even point. </li></ul><ul><li>EPS is zero at Fin Break Even point </li></ul><ul><li>Each level of EBIT has different DFL </li></ul><ul><li>It indicates the financial risk of the firm. </li></ul>
  8. 9. Total Leverage <ul><li>Combination of DOL & DFL. </li></ul><ul><li>It’s a measure of impact in change in output/sales on the EPS of the company </li></ul><ul><li>DTL=% change in EPS/ % change in output. </li></ul><ul><li>Or DTL= Q(s-v)/(Q(s-v)-F-I-{Pref Div/(i-t)}) </li></ul><ul><li>Measure of Total Risk </li></ul>

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