Capital Structure
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This document discusses capital structure and leverage. It defines capital structure as the composition of a company's long-term capital sources including loans, reserves, shares and bonds. The optimal capital structure maximizes firm value by balancing the use of debt and equity. Leverage refers to a company's use of fixed-cost funds, like debt, to increase returns to shareholders. Both financial leverage and operating leverage can magnify the impact of changes in revenues and earnings but also increase business risk.
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Capital Structure
The document discusses capital structure, which refers to the composition of a company's long-term financing, including loans, reserves, shares, and bonds. It outlines factors that influence a company's capital structure, both internal factors like financial leverage and risk, and external factors like industry trends and availability of funds. The document also discusses the concept of an optimal capital structure that maximizes firm value and minimizes cost of capital, and explains the point of indifference where earnings per share remains the same regardless of the debt-equity mix. Leverage is defined as a company's ability to use fixed-cost assets or funds to increase returns to owners, and different types of leverage including financial, operating, combined, and working capital leverage are described
Capital structure
The document discusses capital structure, which refers to the composition of a company's long-term financing, including loans, reserves, shares, and bonds. It outlines factors that influence a company's capital structure such as financial leverage, risk, growth, and external conditions. The document also discusses the concept of an optimal capital structure that maximizes firm value and minimizes the cost of capital. It notes different types of leverage including financial, operating, combined, and working capital leverage and how they impact a company's earnings and risk.
Capital structure
* Firm X is leveraged as it has Rs. 500000 debentures while Firm Y is unleveraged
* EBIT of both firms is Rs. 100000
* Equity capitalisation rate of Firm X is 17% while that of Firm Y is 13%
* Investor A holds 10% shares of Firm X
* As per MM theory, this difference in capitalisation rate cannot exist for long due to arbitrage process
* Investor A will sell shares of Firm X whose capitalisation rate is higher and buy shares of similar value of Firm Y whose capitalisation rate is lower
* This will increase demand and price of shares of Firm Y and reduce price of shares of Firm X
* The process will continue till
Capital Structure
The capital structure of a company refers to the composition of its long-term financing, including loans, reserves, shares, and bonds. A company's capital structure is influenced by both internal factors like financial leverage, risk tolerance, and growth plans as well as external factors like industry norms, availability of funds, and tax policies. An optimal capital structure maximizes the value of the company by balancing the use of debt financing which increases earnings per share but also increases financial risk. The point of indifference is the earnings level at which earnings per share remains the same regardless of the debt-to-equity mix. Leverage refers to using fixed-cost funds to increase returns to owners, either through financial leverage of long-term debt or operating
Capitalization and capital structure
This document discusses capitalization and capital structure. It defines capitalization as the total value of capital employed in a business. Capital structure comprises ownership capital and borrowed capital. An optimum capital structure balances risk and return with minimal cost of capital. Both over-capitalization and under-capitalization are disadvantageous, though under-capitalization can increase returns. Determinants of capital structure include cost of capital, firm size and nature, financial leverage, cost of raising funds, growth and stability of sales, and legal/tax factors.
Capital structure
The document discusses capital structure, which refers to the types of securities (debt vs equity) and their proportions that make up a company's total capital. An optimal capital structure minimizes a company's cost of capital. Factors that affect a company's capital structure choice include financial leverage, growth stability, cost of capital, risk tolerance, cash flow ability to service debt, firm size and nature, control and flexibility needs, and capital market conditions.
Capital Structure
A corporation finances itself through a combination of equity and debt. The capital structure should be designed to maximize the long-term market valuation of the firm. The determinants of a company's capital structure include the type of assets financed, the nature of the industry, the degree of competition, potential for obsolescence, the product life cycle stage, financial policies, past capital structure decisions, issues of corporate control, and credit ratings.
Capital structure
Capital structure refers to the composition of long-term capital from sources like loans, reserves, shares, and bonds. It represents the relationship between different types of long-term capital. A proper capital structure maximizes firm value, minimizes costs, and increases share prices. It also allows firms to take advantage of new investment opportunities and supports country growth. Factors that affect capital structure include financial leverage, operating leverage, earnings per share, costs of different sources, growth and stability of sales, flexibility, nature and size of firm, cash flows, control, market conditions, asset structure, financing purpose, and period of finance. Advantages of debt include amplifying returns, greater control and flexibility, while equity provides flexibility in raising funds
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Capital Structure
The document discusses capital structure, which refers to the composition of a company's long-term financing, including loans, reserves, shares, and bonds. It outlines factors that influence a company's capital structure, both internal factors like financial leverage and risk, and external factors like industry trends and availability of funds. The document also discusses the concept of an optimal capital structure that maximizes firm value and minimizes cost of capital, and explains the point of indifference where earnings per share remains the same regardless of the debt-equity mix. Leverage is defined as a company's ability to use fixed-cost assets or funds to increase returns to owners, and different types of leverage including financial, operating, combined, and working capital leverage are described
Capital structure
The document discusses capital structure, which refers to the composition of a company's long-term financing, including loans, reserves, shares, and bonds. It outlines factors that influence a company's capital structure such as financial leverage, risk, growth, and external conditions. The document also discusses the concept of an optimal capital structure that maximizes firm value and minimizes the cost of capital. It notes different types of leverage including financial, operating, combined, and working capital leverage and how they impact a company's earnings and risk.
Capital structure
* Firm X is leveraged as it has Rs. 500000 debentures while Firm Y is unleveraged
* EBIT of both firms is Rs. 100000
* Equity capitalisation rate of Firm X is 17% while that of Firm Y is 13%
* Investor A holds 10% shares of Firm X
* As per MM theory, this difference in capitalisation rate cannot exist for long due to arbitrage process
* Investor A will sell shares of Firm X whose capitalisation rate is higher and buy shares of similar value of Firm Y whose capitalisation rate is lower
* This will increase demand and price of shares of Firm Y and reduce price of shares of Firm X
* The process will continue till
Capital Structure
The capital structure of a company refers to the composition of its long-term financing, including loans, reserves, shares, and bonds. A company's capital structure is influenced by both internal factors like financial leverage, risk tolerance, and growth plans as well as external factors like industry norms, availability of funds, and tax policies. An optimal capital structure maximizes the value of the company by balancing the use of debt financing which increases earnings per share but also increases financial risk. The point of indifference is the earnings level at which earnings per share remains the same regardless of the debt-to-equity mix. Leverage refers to using fixed-cost funds to increase returns to owners, either through financial leverage of long-term debt or operating
Capitalization and capital structure
This document discusses capitalization and capital structure. It defines capitalization as the total value of capital employed in a business. Capital structure comprises ownership capital and borrowed capital. An optimum capital structure balances risk and return with minimal cost of capital. Both over-capitalization and under-capitalization are disadvantageous, though under-capitalization can increase returns. Determinants of capital structure include cost of capital, firm size and nature, financial leverage, cost of raising funds, growth and stability of sales, and legal/tax factors.
Capital structure
The document discusses capital structure, which refers to the types of securities (debt vs equity) and their proportions that make up a company's total capital. An optimal capital structure minimizes a company's cost of capital. Factors that affect a company's capital structure choice include financial leverage, growth stability, cost of capital, risk tolerance, cash flow ability to service debt, firm size and nature, control and flexibility needs, and capital market conditions.
Capital Structure
A corporation finances itself through a combination of equity and debt. The capital structure should be designed to maximize the long-term market valuation of the firm. The determinants of a company's capital structure include the type of assets financed, the nature of the industry, the degree of competition, potential for obsolescence, the product life cycle stage, financial policies, past capital structure decisions, issues of corporate control, and credit ratings.
Capital structure
Capital structure refers to the composition of long-term capital from sources like loans, reserves, shares, and bonds. It represents the relationship between different types of long-term capital. A proper capital structure maximizes firm value, minimizes costs, and increases share prices. It also allows firms to take advantage of new investment opportunities and supports country growth. Factors that affect capital structure include financial leverage, operating leverage, earnings per share, costs of different sources, growth and stability of sales, flexibility, nature and size of firm, cash flows, control, market conditions, asset structure, financing purpose, and period of finance. Advantages of debt include amplifying returns, greater control and flexibility, while equity provides flexibility in raising funds
Capital Structure and Leverage
The capital structure of a firm refers to how it finances its operations through various sources of funds, including debt through bonds or notes, and equity such as common stock, preferred stock, or retained earnings. Capital structure planning is important for a firm's long-term survival by creating a strong balance sheet and allowing a firm to withstand losses. An optimal capital structure balances debt and equity to lower the cost of capital and maximize firm value. Leverage refers to using assets or funds with fixed costs to magnify earnings, and comes in operating, financial, and combined forms. Operating leverage is concerned with fixed costs in a firm's income, while financial leverage uses debt to potentially increase earnings per share.
Capital Structure Theory
The document discusses capital structure and leverage. It defines capital structure and discusses questions to consider when making financing decisions, such as determining the optimal financing mix. Appropriate capital structures should have features like profitability, solvency, flexibility, capacity, and control. Capital structure is determined by factors like taxes, flexibility, industry norms, and investor requirements. Firms can use different forms of capital structure involving various proportions of equity, debt, and preference shares. Financial leverage refers to using debt financing to magnify returns, and it can be measured using ratios like debt ratio and interest coverage. Capital structure theories address whether firm value depends on capital structure.
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Qualities of a good capital structure
The document discusses qualities of a good capital structure. It defines capital structure as the mix of long-term funding sources like debt and equity. An optimal capital structure maximizes firm value and minimizes average cost of capital. Qualities of a good capital structure include profitability, solvency/risk, flexibility, minimum cost of capital, safety of investment, and control. It should allow maximum returns through leverage at low cost while balancing debt and equity to control risk.
Factors affecting capital structure
This document discusses factors that affect a company's capital structure. It defines capital structure as how a firm finances its operations through various sources of funds such as debt, equity, short-term debt, and other financing options. It then lists 14 factors that influence a company's capital structure decisions, including control interests of shareholders, risks, tax considerations, cost of capital, flexibility, investors' attitudes, legal provisions, growth rate, market conditions, profitability, floatation costs, cost of debt, cost of equity capital, and government policies. Maintaining an optimal capital structure is important for balancing business risks and maximizing shareholder value.
Capital structure and its Determinants
This document discusses capital structure and its determinants. It defines capital structure as the mix of different securities used to finance a firm's operations, including bonds, loans, ordinary shares, and preferred shares. It then lists and describes various determinants that must be considered when determining a firm's optimal capital structure, including financial leverage, growth and stability of sales, cost of capital, cash flow ability, nature and size of the firm, control, flexibility, requirements of investors, capital market conditions, assets structure, purpose and period of financing, costs of floating securities, personal considerations, corporate tax rates, and legal requirements. Finally, it briefly outlines four major capital structure theories: the net income approach, net operating income approach, Modig
Capital structure.
The document discusses capital structure, which refers to the proportion of debt, preferred stock, and common equity used to finance a company's assets. Capital structure includes long-term debt and stockholder equity. Capitalization refers to the total amount of securities issued, while capital structure refers to the types and proportions of securities. Financial structure includes all financial resources, both short- and long-term. An optimal capital structure maximizes share price and minimizes cost of capital. Factors that determine a company's capital structure include financial leverage, growth and stability of sales, cost of capital, cash flow ability, nature and size of the firm, control, flexibility, requirements of investors, and capital market conditions.
Financial management
1) The capital structure of a firm refers to how it finances its operations and growth through different sources of funds, including debt, equity, and retained earnings.
2) Several factors influence a firm's capital structure decisions, including business risk, tax exposure, financial flexibility, management style, growth rate, and market conditions.
3) Business risk, tax rates, financial flexibility, management aggressiveness, growth needs, and market access all impact the optimal mix of debt and equity financing for firms.
3 capital structure
The document discusses capital structure and the factors considered when determining a firm's optimal capital structure. It defines capital structure as the mix of long-term financing sources like debt, preference shares, and equity. Management should choose a capital structure that minimizes the firm's cost of capital while maximizing shareholder value. Different approaches for determining the optimal capital structure are described, including the net income, net operating income, Modigliani-Miller, and traditional intermediate approaches.
Capital structure
The document discusses various aspects of capital structure including definitions, key terms, theories, and principles. It defines capital structure as the mix of debt and equity used by a company to finance its overall operations and long-term needs. Several theories of capital structure are described, including the net income approach, net operating income approach, and Modigliani & Miller approach. Factors that determine an optimal capital structure are discussed, including costs, risks, flexibility, and control. Formulas for calculating financial break-even point, point of indifference, and capital gearing ratio are provided. Examples are given to illustrate how to apply the concepts.
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Capital Structure
The document defines capital structure as the composition of a company's long-term financing, including loans, reserves, shares, and bonds. It discusses factors that influence a company's capital structure such as financial leverage, risk, growth, and cost of capital. It also discusses the concept of an optimal capital structure that maximizes firm value. The document then covers related topics like the point of indifference, types of leverage including financial and operating leverage, and how they impact a company's earnings.
Capital Structure
The document defines capital structure as the permanent long-term financing of a company, including long-term debt, common stock, preferred stock, and retained earnings. It discusses the concept of optimal capital structure, which minimizes a firm's cost of capital. The document also outlines various approaches to establishing capital structure, including EBIT-EPS analysis and cash flow analysis. It evaluates capital structure based on factors like flexibility, risk, return, and control.
Capital structure
The document discusses capital structure, asset structure, financial structure, and optimal capital structure. It defines capital structure as the permanent financing of a firm through long-term debt, preferred stock, and net worth. Financial structure includes current liabilities in addition to capital structure. Optimal capital structure is the combination of debt and equity that achieves goals like maximizing returns in the most effective way. Determinants of capital structure include the nature of business, stability of earnings, growth rate, and costs of capital.
Capital structure
Capital structure refers to how a corporation finances its assets through a combination of equity, debt, or securities. A firm's capital structure composition includes liabilities like debt and equity shares. Equity shares make shareholders owners but do not burden the company, while debt provides tax advantages but requires regular payments. An optimal capital structure considers advantages and disadvantages of different sources to maximize utilization of resources.
Traditional and MM approach in capital structure
The document discusses traditional and Modigliani-Miller (MM) approaches to capital structure.
The traditional approach argues that a company's value and cost of capital can be optimized through a judicious mix of debt and equity, up to a certain level of debt. Beyond this, increased financial risk from more debt outweighs the benefits of cheaper debt.
The MM approach argues that a company's value depends only on its operating income and risk, not its capital structure. It proposes that markets will equalize any differences in value or cost of capital through arbitrage. The cost of equity rises in line with debt, keeping the weighted average cost of capital constant.
While influential, the MM approach makes
Capitalisation
a word ordinarily used to refer to the sum of outstanding stocks and funded obligations which may represent fictitious values
Capital structure ppt
The document discusses capital structure and its theories. It defines capital structure as the proportion of long-term debt and equity used to finance a company's assets. A company's capital structure determines its risk and cost of capital. There are several theories on capital structure including the net income, net operating income, traditional, and Modigliani-Miller approaches. The optimal capital structure balances minimum costs and risks. Factors like tax rates, control, flexibility, and legal requirements influence a company's choice of capital structure.
Capital structure theories 1
The document discusses several theories of capital structure:
1) Net income approach assumes capitalization rates are constant as debt increases, making 100% debt optimal.
2) Net operating income approach finds no optimal structure as equity rates adjust to keep overall rates constant.
3) Traditional approach finds an optimal structure where costs initially fall then rise with more debt.
4) MM theory initially argues capital structure is irrelevant without taxes but debt provides tax shields with taxes.
5) Trade-off theory balances tax shields against costs of financial distress and agency, finding an optimal balance.
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1) The document provides the balance sheet of R Ltd. as of March 2008 and details of a scheme of reconstruction approved on April 1, 2008.
2) Key terms of the reconstruction include reducing preference share capital by Rs. 2.5 per share and equity share capital by Rs. 7.5 per share, revaluing certain assets, eliminating debit balances, and directors settling loans by taking equity shares.
3) The required ledger accounts are presented to effect the changes outlined in the reconstruction scheme, along with the balance sheet of R Ltd. after reconstruction as of April 1, 2008.
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The document discusses capital structure and leverage. It defines capital structure and discusses questions to consider when making financing decisions, such as determining the optimal financing mix. Appropriate capital structures should have features like profitability, solvency, flexibility, capacity, and control. Capital structure is determined by factors like taxes, flexibility, industry norms, and investor requirements. Firms can use different forms of capital structure involving various proportions of equity, debt, and preference shares. Financial leverage refers to using debt financing to magnify returns, and it can be measured using ratios like debt ratio and interest coverage. Capital structure theories address whether firm value depends on capital structure.
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The document discusses qualities of a good capital structure. It defines capital structure as the mix of long-term funding sources like debt and equity. An optimal capital structure maximizes firm value and minimizes average cost of capital. Qualities of a good capital structure include profitability, solvency/risk, flexibility, minimum cost of capital, safety of investment, and control. It should allow maximum returns through leverage at low cost while balancing debt and equity to control risk.
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This document discusses factors that affect a company's capital structure. It defines capital structure as how a firm finances its operations through various sources of funds such as debt, equity, short-term debt, and other financing options. It then lists 14 factors that influence a company's capital structure decisions, including control interests of shareholders, risks, tax considerations, cost of capital, flexibility, investors' attitudes, legal provisions, growth rate, market conditions, profitability, floatation costs, cost of debt, cost of equity capital, and government policies. Maintaining an optimal capital structure is important for balancing business risks and maximizing shareholder value.
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This document discusses capital structure and its determinants. It defines capital structure as the mix of different securities used to finance a firm's operations, including bonds, loans, ordinary shares, and preferred shares. It then lists and describes various determinants that must be considered when determining a firm's optimal capital structure, including financial leverage, growth and stability of sales, cost of capital, cash flow ability, nature and size of the firm, control, flexibility, requirements of investors, capital market conditions, assets structure, purpose and period of financing, costs of floating securities, personal considerations, corporate tax rates, and legal requirements. Finally, it briefly outlines four major capital structure theories: the net income approach, net operating income approach, Modig
Capital structure.
The document discusses capital structure, which refers to the proportion of debt, preferred stock, and common equity used to finance a company's assets. Capital structure includes long-term debt and stockholder equity. Capitalization refers to the total amount of securities issued, while capital structure refers to the types and proportions of securities. Financial structure includes all financial resources, both short- and long-term. An optimal capital structure maximizes share price and minimizes cost of capital. Factors that determine a company's capital structure include financial leverage, growth and stability of sales, cost of capital, cash flow ability, nature and size of the firm, control, flexibility, requirements of investors, and capital market conditions.
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1) The capital structure of a firm refers to how it finances its operations and growth through different sources of funds, including debt, equity, and retained earnings.
2) Several factors influence a firm's capital structure decisions, including business risk, tax exposure, financial flexibility, management style, growth rate, and market conditions.
3) Business risk, tax rates, financial flexibility, management aggressiveness, growth needs, and market access all impact the optimal mix of debt and equity financing for firms.
3 capital structure
The document discusses capital structure and the factors considered when determining a firm's optimal capital structure. It defines capital structure as the mix of long-term financing sources like debt, preference shares, and equity. Management should choose a capital structure that minimizes the firm's cost of capital while maximizing shareholder value. Different approaches for determining the optimal capital structure are described, including the net income, net operating income, Modigliani-Miller, and traditional intermediate approaches.
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The document discusses various aspects of capital structure including definitions, key terms, theories, and principles. It defines capital structure as the mix of debt and equity used by a company to finance its overall operations and long-term needs. Several theories of capital structure are described, including the net income approach, net operating income approach, and Modigliani & Miller approach. Factors that determine an optimal capital structure are discussed, including costs, risks, flexibility, and control. Formulas for calculating financial break-even point, point of indifference, and capital gearing ratio are provided. Examples are given to illustrate how to apply the concepts.
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The document defines capital structure as the composition of a company's long-term financing, including loans, reserves, shares, and bonds. It discusses factors that influence a company's capital structure such as financial leverage, risk, growth, and cost of capital. It also discusses the concept of an optimal capital structure that maximizes firm value. The document then covers related topics like the point of indifference, types of leverage including financial and operating leverage, and how they impact a company's earnings.
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The document defines capital structure as the permanent long-term financing of a company, including long-term debt, common stock, preferred stock, and retained earnings. It discusses the concept of optimal capital structure, which minimizes a firm's cost of capital. The document also outlines various approaches to establishing capital structure, including EBIT-EPS analysis and cash flow analysis. It evaluates capital structure based on factors like flexibility, risk, return, and control.
Capital structure
The document discusses capital structure, asset structure, financial structure, and optimal capital structure. It defines capital structure as the permanent financing of a firm through long-term debt, preferred stock, and net worth. Financial structure includes current liabilities in addition to capital structure. Optimal capital structure is the combination of debt and equity that achieves goals like maximizing returns in the most effective way. Determinants of capital structure include the nature of business, stability of earnings, growth rate, and costs of capital.
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Capital structure refers to how a corporation finances its assets through a combination of equity, debt, or securities. A firm's capital structure composition includes liabilities like debt and equity shares. Equity shares make shareholders owners but do not burden the company, while debt provides tax advantages but requires regular payments. An optimal capital structure considers advantages and disadvantages of different sources to maximize utilization of resources.
Traditional and MM approach in capital structure
The document discusses traditional and Modigliani-Miller (MM) approaches to capital structure.
The traditional approach argues that a company's value and cost of capital can be optimized through a judicious mix of debt and equity, up to a certain level of debt. Beyond this, increased financial risk from more debt outweighs the benefits of cheaper debt.
The MM approach argues that a company's value depends only on its operating income and risk, not its capital structure. It proposes that markets will equalize any differences in value or cost of capital through arbitrage. The cost of equity rises in line with debt, keeping the weighted average cost of capital constant.
While influential, the MM approach makes
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The document discusses several theories of capital structure:
1) Net income approach assumes capitalization rates are constant as debt increases, making 100% debt optimal.
2) Net operating income approach finds no optimal structure as equity rates adjust to keep overall rates constant.
3) Traditional approach finds an optimal structure where costs initially fall then rise with more debt.
4) MM theory initially argues capital structure is irrelevant without taxes but debt provides tax shields with taxes.
5) Trade-off theory balances tax shields against costs of financial distress and agency, finding an optimal balance.
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Capital Structure
- 1. Capital Structure Meaning Factors influencing capital structure Optimal capital structure Point of Indifference Reasons for changes in capital structure Leverages Types of leverages Definition “ Capital structure of a company refers to the composition of its capitalisation and it includes all long term capital sources i.e., loans, reserves, shares and bonds”. –Gerestenbeg “ the Capital structure of business can be measured by the ratio of various kinds of permanent loan and equity capital to total capital”. - Schwarty Factors affecting capital structure INTERNAL Financial leverage Risk Growth and stability Retaining control Cost of capital Cash flows Flexibility Purpose of finance Asset structure EXTERNAL Size of the company Nature of the industry Investors Cost of inflation Legal requirements Period of finance Level of interest rate Level of business activity Availability of funds Taxation policy Level of stock prices Conditions of the capital market Optimal capital structure The OCM can be defined as “ that capital structure or combination of debt and equity that leads to the maximum value of the firm” OCM maximises the value of the company and hence the wealth of its owners and minimise the company’s cost of capital. the following consideration should be kept in mind while maximising the value of the firm in achieving the goal of the optimal capital structure: 1. If ROI > the fixed cost of funds, the company should prefer to raise the funds having a fixed cost, such as, debentures, Loans and PSC. It will increase EPS and MV of the firm.
- 2. 2. If debt is used as a source of finance, the firm saves a considerable amount in payment of tax as interest is allowed as a deductible expense in computation of tax. 3. It should also avoid undue financial risk attached with the use of increased debt financing 4. The Capital structure should be flexible. Point of indifference / Range of earnings The earnings per share, ‘equivalent point’ or ‘point of indifference’ refers to that EBIT, level at which EPS remains the same irrespective of Different alternatives of Debt-Equity mix. At this level of EBIT, the rate of return on capital employed is equal to the cost of debt and this is also known as the break-even level of EBIT for alternative financial plans Capital Gearing CG means the ratio between the various types of securities in the capital structure of the company. A company is said to e high-gear when it has proportionately higher/larger issue of Debt and PS for raising the LT resources. Whereas low-gear stands for a proportionately large issue of equity shares. Leverage Leverage-an Increased means of accomplishing some purpose In financial management, it is the firms ability to use fixed cost assets or funds to increase the returns to its owners; Financial leverage- the use of long term fixed income bearing debt and preference share capital along with the equity share capital is called financial leverage or trading on equity A Firm is known to have a favourable leverage if its earnings are more than what debt would cost. On the contrary, if it does not earn as much as the debt costs then it will be known as an unfavourable leverage. Impact of financial leverage When the d/f b/w the earnings from assets financed by fixed cost funds and cost of these funds are distributed to the equity stockholders, they will get additional earnings without increasing their own investment. Consequently, the EPS and the Rate of return on ESC will go up. On the contrary, if the firm acquires fixed cost funds at a higher cost than the earnings from those assets then the EPS and return on equity capital will decrease. Significance of financial leverage Planning of capital structure Profit planning Limitations of FL/ trading on equity Double-edged weapon Beneficial only to companies having stability in earnings Increases risk and rate of interest Restriction from financial instruments Operating leverage Operating leverage results from the presence of fixed costs the help in magnifying net operating income fluctuations flowing from small variations in revenue. The changes in sales are related to changes in the revenue. The fixed costs do not change with the changes in sales, any increase in sales, FC remaining the same, will magnify operating revenue
- 3. OL shows the ability of a firm to use fixed operating cost to increase the effect of change in sales and the charges in fixed operating income. Combined leverage The OL affects the income which is the result of production. On the other hand, FL is the result of financial decisions. The CL focuses attention on the entire income of the concern This leverage shows the relationship between a change in sales and the corresponding variation in taxable income. Working capital leverage This leverage measures the sensitivity of ROI of changes in the level of current assets.