What do you mean by financial leverage, Financial Management

Assignment Help:

Q. What do you mean by Financial Leverage?

Financial Leverage: - The financial leverage perhaps defined as the tendency of the residual net profit to vary disproportionately with operating profit. It point outs the change that take place in the taxable income as a result of change in the operating income. It implies the existence of fixed interest/ fixed dividend bearing securities in the total capital structure of the company. Therefore the use of fixed interest/ dividend bearing securities such as debt & capital preference along with the owner's equity in the total owner capital structure of the company is described as financial leverage. Where in capital formation of the company the fixed interest /dividend bearing securities are greater as compared to the equity capital the leverage is said to be larger. In the repeal case the leverage will be said to be smaller.

Favourable as well as Unfavourable financial leverage: - Financial leverage possibly favourable or unfavourable upon whether the earning made by the use of fixed interest or dividend - bearing securities surpass the or not explicit the fixed cost the firm has to pay for the employment of such funds. The leverage will be determined to be favourable so long the firm earns more on assets purchased with the funds than the fixed cost of there use unfavourable or negative leverage occurs when the firm doesn't earns as much as the fund cost.

Financial leverage is as well termed as 'trading on equity'. The corporation resorts to trading on equity with the objective of giving the equity shareholders higher rate of return than the general rate of earning on capital employed in the company to compensate them for the risk that they have to bear. For instance - If a company borrows Rs. 100 @ 10% P.a and earns a return for 12% the balance 4% p.a. Subsequent to payment of interest belongs to the shareholders and therefore they can be paid a higher rate of return than the general rate of earning of company. However in case company could earn a return of only 6% on Rs 100 employed by it the equity shareholders loss will be Rs. 2 p.a Therefore the financial leverage is a double - edged sword. It has the potentially of rising the return to equity shareholders.

Formulae: - Financial leverage = Earning before tax and Interest / Profit before tax but after interest


Related Discussions:- What do you mean by financial leverage

Measurement of interest rate risk, Changes in the bond value is inversely ...

Changes in the bond value is inversely related to the change in the interest rates. If an investor holds a long bond position, he would incur loss if the in

Define the type of bond instrument, You are an investment banker advising a...

You are an investment banker advising a Eurobank with reference to a new international bond offering it is considering.  The carries on are to be employed to fund Eurodollar loans

Determine the weighted average cost of capital, To evaluate a company using...

To evaluate a company using enterprise discounted cash flow (DCF), we discount free cash flow by the weighted average cost of capital (WACC). The weighted average cost of capital r

Operating economics, Q Operating economics A number of operating econo...

Q Operating economics A number of operating economies will be available with the merger of two or more companies. Duplicating facilities in accounting purchasing marketing etc

What spot exchange should one forecast 5 years into future, The current spo...

The current spot exchange rate is Dr240/$1.00. Long-run inflation in Greece is calculated at 8 percent yearly and 4.5% in the United States.  If PPP is expected to hold among the t

Explain the methods used to treat the obsolete stock, Explain the methods u...

Explain the methods used to treat the obsolete stock Review Inventory for obsolete items Make materials review board Include an obsolescence review in the closing p

Define a currency futures contract, Q. Define a currency futures contract? ...

Q. Define a currency futures contract? A currency futures contract is a standardised contract for the buying or else selling of a specified quantity of currency. It is traded o

Assignment, Imagine you have been allocated $100,000 which is to be investe...

Imagine you have been allocated $100,000 which is to be invested in 8 companies listed on the Australian Stock Exchange (ASX). You are required to have a balanced portfolio betwee

Compare and contrast the potential liability, Compare and contrast the pote...

Compare and contrast the potential liability of owners of proprietorships, partnerships (general partners), and corporations. The sole proprietor has limitless liability for ma

What are the coupon bonds security instruments, What are the coupon bonds s...

What are the coupon bonds security instruments? Coupon bonds are contractual agreements by the borrowers to make regular payments (known as coupons or interest) until a specifi

Write Your Message!

Captcha
Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd