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Types of Leverage

The document discusses three types of leverage: operating leverage, financial leverage, and combined leverage. Operating leverage measures how fixed costs affect operating profits with changes in sales. Financial leverage examines how the use of debt versus equity in a company's capital structure impacts earnings per share. Combined leverage looks at the combined effects of operating and financial leverage. Key formulas are provided to calculate the degrees of operating, financial, and combined leverage. The document also outlines the importance of leverage in areas like profit planning and risk analysis.

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LUEE SAHOO
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228 views16 pages

Types of Leverage

The document discusses three types of leverage: operating leverage, financial leverage, and combined leverage. Operating leverage measures how fixed costs affect operating profits with changes in sales. Financial leverage examines how the use of debt versus equity in a company's capital structure impacts earnings per share. Combined leverage looks at the combined effects of operating and financial leverage. Key formulas are provided to calculate the degrees of operating, financial, and combined leverage. The document also outlines the importance of leverage in areas like profit planning and risk analysis.

Uploaded by

LUEE SAHOO
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPTX, PDF, TXT or read online on Scribd
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TYPES OF

LEVERAGE
SUBMITTED BY
Name - LUEE SAHOO
Regd no. - 190402100039
LEVERAGE

Leverage is an investment strategy of using borrowed


money—specifically, the use of various financial
instruments or borrowed capital—to increase the
potential return of an investment. Leverage can also
refer to the amount of debt a firm uses to finance assets.
TYPES
OPERATING LEVERAGE
Operating leverage is a measurement of the degree to which a firm incurs a
combination of fixed and variable cost. But it does not include interest on
debt capital. Higher the proportion of fixed operating cost as compared to
variable cost, higher is the operating leverage, and vice versa.
Operating leverage may be defined as the “firm’s ability to use fixed
operating cost to magnify effects of changes in sales on its earnings before
interest and taxes.”
A FIRM WILL HAVE THREE TYPES OF
COST
(i) Variable cost that tends to vary in direct proportion to the change in the
volume of activity,
(ii) Fixed costs which tend to remain fixed irrespective of variations in the
volume of activity within a relevant range and during a defined period of
time,
(iii) Semi-variable or Semi-fixed costs which are partly fixed and partly
variable. They can be segregated into variable and fixed elements and
included in the respective group of costs.
THE FORMULA USED
DEGREE
It measures how much is the effect of change in sales on operating
profit.
The degree of operating leverage at any level is expressed in
percentage change in operating profit to percentage change in
sales.
Degree of operating leverage = % change in EBIT / % change in
SALES
IMPORTANCE

PROFIT PLANNING
CAPITAL STRUCTURE PLANNING
RISK ANALYSIS
FINANCIAL LEVERAGE

Financial Leverage is a tool with which a financial manager


can maximize the returns to the equity shareholders. The
capital of a company consists of equity, preference,
debentures, public deposits and other long-term source of
funds. He has to carefully select the securities to mobilize the
funds. The proper blend of debt to equity should be
maintained.
THE FORMULA USED
DEGREE
The degree of financial leverage is defined as the
percentage change in EPS due to the given percentage
change in EBIT.
Degree of financial leverage = % change in EPS / %
change in EBIT
LIMITATION

Increase risk
Beneficial only to companies having stable earning
Restrictions from financial institutions
COMBINED LEVERAGE

It is the combination operating and financial


leverage.
Both of these are closely concerned with firms
capacity to meet its FC & their combined effect will
measure the firms financial strength.
THE FORMULA USED
DEGREE
It is calculated by multiplying the DOL and the DFL and
it is calculated by the formula
Degree of combined leverage = DOL * DFL
i.e. = % change in EPS / % change in SALE
THANK YOU

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