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Leverage and Capital Structure

Leverage refers to using fixed assets or funds to increase returns to owners. Capital structure is the mix of long-term debt and equity that a company maintains. There are three types of leverage: operating, financial, and total. Operating leverage looks at the relationship between sales revenue and EBIT. Financial leverage examines the relationship between EBIT and EPS. Total leverage considers the relationship between sales revenue and EPS. Capital structure theory considers the probability of bankruptcy, asymmetric information, tax benefits, agency costs imposed by lenders, and maximizing EPS within an expected interval for owner returns.

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Lee Fei
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88 views18 pages

Leverage and Capital Structure

Leverage refers to using fixed assets or funds to increase returns to owners. Capital structure is the mix of long-term debt and equity that a company maintains. There are three types of leverage: operating, financial, and total. Operating leverage looks at the relationship between sales revenue and EBIT. Financial leverage examines the relationship between EBIT and EPS. Total leverage considers the relationship between sales revenue and EPS. Capital structure theory considers the probability of bankruptcy, asymmetric information, tax benefits, agency costs imposed by lenders, and maximizing EPS within an expected interval for owner returns.

Uploaded by

Lee Fei
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Leverage and

Capital Structure
VIONA CHARISTA | 212019506
Leverage Capital
Structure
use of fixed cost assets a mix of long-term debt
or funds to increase and equity that the
returns to owners. company maintains.
RISK &
LEVERAGE
RETURN

LEVERAGE RISK &


RETURN
Types of Leverage

Operating Leverage
01 sales revenue relationship
with EBIT.

Financial Leverage Total Leverage


02 the relationship between 03 sales revenue relationship
EBIT and EPS. with EPS.
Table 12.1 General Income Statement Format and
Types of Leverage
Breakeven Analysis

★ Determine the operating


Breakeven: a situation where rate to cover all operating
the level of sales or income costs.
earned and the capital used to
generate profit are in the same ★ Evaluating the level of
position profitability at various
levels of sales.
Operating break even point
The sales rate that can cover all FC and
TVC or EBIT is zero.

EBIT = P x Q – VC x Q – FC, 0 = (P-VC)Q – FC,


Operating
Leverage
The use of fixed operating costs to increase the
effect of changes in sales on EBIT.
The Degree of Operating Leverage
(DOL)
Financial The use of fixed finance costs to increase the effect
of changes in EBIT on EPS.

Leverage Fixed financial cost


Interest and debt | Preferred stock dividends
DFL

Degree of Financial
Leverage
Total Leverage
The use of fixed costs (operating and financial) to
increase the effect of changes in sales on EPS.
The Degree of Total Leverage
(DTL)
Capital Structure of
the firm
Capital: the company's long-term funds
(debt + equity).
Capital Structure Theory

Probability of Asymmetric
Bankruptcy Information

01 02 03 04
Tax Benefits Agency Costs
Imposed by
Lenders
The EBIT-EPS approach is an approach
to choosing a capital structure that
maximizes EPS within the expected
EPS interval (owner's return).
Thank You

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