Give me a lever long enough and a place to stand &

I will move the entire earth. -Archimedes

Presented by:
Ashutosh Mishra
 Leverage

The amount of Debt is that which is owed;

debt used to usually referencing assets
finance a firm's owed, but the term can cover
assets. other obligations.

A firm with
significantly
more debt than The difference between the
equity is Equity market value of a property &
considered to be the claims held against it .
highly leveraged.
 Financial Leverage

Financial leverage is the degree to which a business is utilizing

borrowed money rather then equity to fund it’s operations.

It reflects the amount of debt used in the capital structure of

the firm.

Return on assets (ROA)

Return on equity (ROE)
Earnings before interest and
taxes(EBIT)
Earnings per share(EPS)
Leverage allows greater
potential returns to the
investor than otherwise
would have been
available but the
potential for loss is also
greater because if the
investment becomes
worthless, the loan
principal and all accrued
interest on the loan still
need to be repaid.
Consider the rate of interest paid as fulcrum used in applying forces
through leverage.

Then we can arrive at following conclusions:

Lower the interest rate, greater will be the profit.
Less the chance of loss, less the amount borrowed, the lower will be the
profit or loss.

Degree of financial leverage is defined as %

change in EPS that results from given % change in
EBIT.

The calculation is likewise:

FinLev =(%change in EPS):(%change in EBIT)
 Measures of Financial Leverage

Debt-to-equity ratio = D/E

Debt ratio = D/(D+E)=D/V

Interest Coverage = EBIT/Interest

Leverage analysis of L & T Ltd.

It is a multi-product company in pvt. sector.

Gross sales of company = Rs.8078.46cr
Net profit for year ending 31-mar-02 = Rs.346.80cr
 Net worth 2696.22
Borrowings 1324.31
Profit before interest & 1088.78
tax(PBIT)
Interest(paid) 92.09
Fixed expenses(excluding 1583.30
interest)
* Data is Rs. In Crores

Debt-equity ratio = 1324.31/2696.22=0.49

Debt-to- capital ratio = 1324.31/(2696.22+1324.31)=0.33
Interest coverage = 1088.78/92.09=11.82
Degree of financial leverage = 1.09 (moderate)
Formulae:

EPS=profit after tax or net income/no. of shares

ROE=profit after tax/value of equity

Use of the Du Pont Identity requires that leverage be measured in

terms of total assets divided by shareholders' equity, and this is sometimes
referred to as gearing or simply leverage:

Leverage (gearing) = A / E
 Real Time Data for Indian Companies (‘04)

Company Capital gearing Income gearing

Debt ratio Debt Interest Interest to
equity coverage EBIT ratio
ratio
Indian oil 0.346 0.530 23.6 0.042
Tata motors 0.261 0.353 16.7 0.060
Reliance 0.398 0.660 5.4 0.186
HLL 0.441 0.797 35.1 0.029
ONGC 0.022 0.022 331.00 0.003
 Levels of financial
leverage

There are 4 positions which show a relationship with the level of

financial leverage. First, is the relation of equity and debt, for
instance, the rate of capital. Second is the influences on business
production and cycle of financial leverage. Thirdly the company's
industry and branch whole financial leverage level. And also the
correlation between the current financial leverage ratio of the
company and the middle leverage level. Lastly, the conformity of
company's mission and philosophy with the situation connected to
the relation of financial leverage.
†Cash flow information is relevant
for company’s ability to meet fixed
financial obligations & not reported
earnings.

†Future risk of company isn’t

determined.

†It is only a measure of short term

liquidity rather than leverage.
 References

•Financial Management by I M Pandey, 9th edition.

•The Internet.