Management needs to study leverages in orders to magnify firms owner and capital structure

theory so that we can make decision about the firms optimal capital structure. CALCULATE AND ANALYSE OL & FL TO BE FAMILIAR WITH TAX EFECTS ON VARIOUS CAPITAL STRUCTURES. Impact of fixed and variable operating cost on the firms breakeven point and its OL, because this will have major impact on risk and return. LEVERAGES and Capital structure (mix of long term debt and equity) are closely related as they are linked to capital budgeting decision through the cost of capital. Finance manager calculates these leverage by apply formula and then uses them for taking decision in favour of company's shareholder. Main aim of leverage testing is maximize the earning of shareholder and reduce the risk of company. These concepts are used to minimise the firm total costs and maximize owners wealth. Leverage results from the use of fixed-cost assets or funds to magnify returns to the firms owners. Generally, increases in leverage result in increased return and risk, whereas decreases in leverage result in decreased return and risk. The amount of leverage in the firms capital structurethe mix of long-term debt and equity maintained by the firmcan significantly affect its value by affecting return and risk. Unlike some causes of risk, management has almost complete control over the risk introduced through the use of leverage. Because of its effect on value, the financial manager must understand how to measure and evaluate leverage, particularly when making capital structure decisions. The three basic types of leverage can best be definedwith reference to the firms income statement, as shown in the general income statement format given below: Operating leverage is concerned with the relationship between the firms sales revenue and its earnings before interest and taxes, or EBIT. (EBIT is a descriptive label for operating profits.) Financial leverage is concerned with the relationship between the firms EBIT and its common stock earnings per share (EPS). Total leverage is concerned with the relationship between the firms sales revenue and EPS.

Operating leverage is % change in earning before interest and tax divided by % change in sale . If company is charging fixed cost , the operating leverage tells the EBIT will greater than sale because due to increasing sale of fixed cost per unit will decrease and it will increase EBIT higher than sale .

Formula

Operating Leverage = % change in EBIT / % change in Sale

This leverage is very helpful for finance manager because , if operating leverage is more than or suppose it is two then it means if sale will increase 100% then earning will increase 200% . At this time , finance manager can get more loan for increasing the earning of shareholders .

2. Financial leverage

It is second type of leverage . Financial leverage is known as trading on equity . If any company's finance manager knows that company's return on investment is more than interest on

loan or borrowing obligation . At this time , if company needs more money , then finance manager gets its loan and bought the asset from same loan . So, any technique in which any asset is purchased with loan and trying to increase EPS , then this is called financial leverage .

Formula for calculating financial leverage

= % change in Earning per share / % change in earning before interest and tax

= % change in EPS / % change in EBIT

This formula explains the relationship between % change in EPS and % change in EBIT and after deep study of this financial leverage , finance manager decides to get appropriate loan for buying assets .

3.Combinedleverage

It is the product of operating leverage and financial leverage .

Combined leverage = Operating leverage X financial leverage

= % change in EBIT / % change in sale X % change in EPS / % change in EBIT

High operating leverage and high financial leverage combination is high risky for business . Good combination is that in which lower operating leverage with high financial leverage .