We think you have liked this presentation. If you wish to download it, please recommend it to your friends in any social system. Share buttons are a little bit lower. Thank you!
Presentation is loading. Please wait.
Published byRaina Hurry
Modified over 2 years ago
CHAPTER 4 MEASURES OF LEVERAGE Presenter’s name Presenter’s title dd Month yyyy
1. INTRODUCTION Leverage is the use of fixed costs in a company’s cost structure. -Operating leverage relates to the company’s operating cost structure. -Financial leverage relates to the company’s capital structure. Copyright © 2013 CFA Institute 2 Fixed Costs
WHY WORRY ABOUT LEVERAGE? 1.A company’s use of leverage affects its risk and return. 2.Operating leverage and financial leverage provide insight into a company’s business and its future. 3.Leverage helps us understand a company’s future cash flows and the risk associated with those cash flows and, hence, its valuation. Copyright © 2013 CFA Institute 3
2. LEVERAGE Copyright © 2013 CFA Institute 4 Leverage increases the volatility of earnings and cash flows → hence, it increases risk to suppliers of capital (creditors and owners). Consider two companies, Company One and Company Two, with the following information: Company One Company Two Number of units produced and sold1,000 Sales price per unit€250 Variable cost per unit€125€25 Fixed operating cost€50,000€100,000 Fixed financing expense€5,000€55,000 Debt€50,000€550,000 Equity€700,000€200,000 Total assets€750,000
WHAT DOES LEVERAGE DO EXACTLY? Copyright © 2013 CFA Institute 5 Company Two uses more operating and financial leverage than Company One.
3. BUSINESS RISK AND FINANCIAL RISK Business risk is the risk associated with the volatility in operating earnings. -Business risk is composed of both operating and sales risk. Sales risk is the uncertainty associated with the number of units produced and sold, as well as the sales price. Copyright © 2013 CFA Institute 6 Business Risk Sales Risk Operatin g Risk
OPERATING RISK Operating risk is the risk associated with the mix of variable and fixed operating expenses. -Operating risk is the sensitivity (i.e., elasticity) of operating earnings to changes in unit sales. The degree of operating leverage (DOL) is the ratio of the percentage change in operating income to the percentage change in units sold. The per unit contribution margin is the difference between the sales price and the variable cost per unit. This difference is available to cover fixed operating costs. -Overall, for all units sold, the contribution margin is the difference between total revenues and variable operating costs. Copyright © 2013 CFA Institute 7
DOL Copyright © 2013 CFA Institute 8
EXAMPLE: COMPANY ONE AND COMPANY TWO Copyright © 2013 CFA Institute 9
FINANCIAL RISK Financial risk is the risk associated with the choice of financing the business. -The greater the reliance on fixed-cost obligations, such as debt, the greater the financial risk. -Similar to operating risk, financial risk elasticity is the sensitivity of income available to owners to a change in operating earnings. The degree of financial leverage (DFL) is the ratio of the percentage change in net income to the percentage change in operating income. Copyright © 2013 CFA Institute 10
DFL Copyright © 2013 CFA Institute 11
EXAMPLE: COMPANY ONE AND COMPANY TWO Copyright © 2013 CFA Institute 12 Company One Company Two
RETURN ON EQUITY AND THE DFL The greater the degree of financial leverage, the greater the financial risk. We can see the leveraging effect by looking at the return on equity (ROE) for different levels of units produced and sold. The greater the DFL, the more sensitive the ROE is to changes in the units produced and sold. Copyright © 2013 CFA Institute 13
EXAMPLE: RETURN ON EQUITY Consider the example of Company One and Company Two: Copyright © 2013 CFA Institute 14
DEGREE OF TOTAL LEVERAGE Copyright © 2013 CFA Institute 15
EXAMPLE: COMPANY ONE AND COMPANY TWO Copyright © 2013 CFA Institute 16 Company One Company Two
BREAKEVEN QUANTITY Copyright © 2013 CFA Institute 17
EXAMPLE: COMPANY ONE AND COMPANY TWO Copyright © 2013 CFA Institute 18 Company One Company Two
RISKS TO CREDITORS AND OWNERS Copyright © 2013 CFA Institute 19 Business risk is affected by demand uncertainty, output price uncertainty, and cost uncertainty. Financial risk adds to the company’s business risk, increasing the risk to creditors and owners. The creditor claims are fixed, whereas the equity claims are residual. In the event that creditor claims cannot be satisfied, there may be legal statuses that help sort out the claims: -Reorganization is the restructuring of claims, with the expectation that the company will be able to continue, in some form, as a going concern. -Liquidation is the situation in which assets are sold and then the proceeds distributed to claimants.
4. SUMMARY Leverage is the use of fixed costs in a company’s cost structure. Business risk is the risk associated with operating earnings and reflects -sales risk (uncertainty with respect to the price and quantity of sales) and -operating risk (the risk related to the use of fixed costs in operations). Financial risk is the risk associated with how a company finances its operations (i.e., the split between equity and debt financing of the business). Copyright © 2013 CFA Institute 20
SUMMARY (CONTINUED) The degree of operating leverage (DOL) is the sensitivity of operating earnings to changes in units produced and sold. The degree of financial leverage (DFL) is the sensitivity of cash flows to owners to changes in operating earnings. The degree of total leverage (DTL) is the sensitivity of the cash flows to owners to changes in unit sales. The breakeven point, Q BE, is the number of units produced and sold at which the company’s net income is zero. The operating breakeven point, Q OBE, is the number of units produced and sold at which the company’s operating income is zero. Copyright © 2013 CFA Institute 21
13-1 CHAPTER 13 Capital Structure and Leverage Business vs. financial risk Optimal capital structure Operating leverage Capital structure theory.
Copyright © 2009 Pearson Prentice Hall. All rights reserved. Chapter 11 Leverage and Capital Structure.
Copyright © 2003 Pearson Education, Inc. Slide 11-0 Ch 11 Learning Goals 1.Operating, financial, and total leverage (causes & measures). 2.Business risk,
1 FINC3131 Business Finance Chapter 4: Financial Statement Analysis.
Capital Structure and Leverage Chapter 13 Sources of Risk Business, Financial, & Operating.
Chapter 4 Financial Planning and Forecasting Additional Funds Needed (AFN) Operating and Financial Breakeven Operating and Financial Leverage.
Leverage. Copyright © 2006 Pearson Addison-Wesley. All rights reserved Leverage Leverage results from the use of fixed-cost assets or funds to magnify.
8-1 Chapter 8 Overview of Working Capital Management © Pearson Education Limited 2004 Fundamentals of Financial Management, 12/e Created by: Gregory A.
Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Analyzing Financial Statements Chapter 14.
WEEK 1 You have 10 seconds to name…
Accounting: What the Numbers Mean Study Outline and Overhead Master Chapter 11.
Addition 1’s to
CHAPTER 6 DIVIDENDS AND SHARE REPURCHASES: BASICS Presenter’s name Presenter’s title dd Month yyyy.
Chapter 12. Determining the Financing Mix Chapter Objectives Business Risk and Financial Risk Break-even analysis Operating leverage, financial leverage,
Chapter 16 The Financial Plan. Copyright © Houghton Mifflin Company16-2 Overview Estimating sales and capital expenditures Preparing the pro forma income.
McGraw-Hill/Irwin Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin © The McGraw-Hill Companies, Inc., Analysis of Financial Statements Chapter 17.
1 PowerPointPresentation by PowerPoint Presentation by Gail B. Wright Professor Emeritus of Accounting Bryant University © Copyright 2007 Thomson South-Western,
Operating and Financial Leverage 5 Chapter Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved. McGraw-Hill/Irwin.
Ch. 2 - Understanding Financial Statements, Taxes, and Cash Flows, Prentice Hall, Inc.
Cost-Volume-Profit Relationships Chapter LEARNING OBJECTIVES 1.Explain how changes in activity affect contribution margin. 2.Compute the contribution.
FINANCIAL STATEMENT ANALYSIS UNISEL. 1. INTRODUCTION Financial analysis is a process of selecting, evaluating, and interpreting financial data, along.
Addition Facts = = =
Operating and Financial Leverage Chapter 5. Chapter 5 - Outline What is Leverage? Break-Even (BE) Point Operating Leverage Financial Leverage Leverage.
Copyright © 2003 Pearson Education, Inc. Slide 12-0 Ch 12 Learning Goals 1.Operating, financial, and total leverage (causes & measures). 2.Optimal capital.
PROFITABILITY RATIOS. SO 5 Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency. Ratio Analysis Profitability.
CHAPTER 5 CAPITAL STRUCTURE Presenters name Presenters title dd Month yyyy.
Profit, Profitability, and Break-Even Analysis. Learning Objectives Understand the difference between efficiency and effectiveness. Distinguish between.
1 CHAPTER 5 ESSENTIALS OF FINANCIAL STATEMENT ANALYSIS.
Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 14-1.
Chapter 14 Short-Term Financial Planning. Copyright ©2014 Pearson Education, Inc. All rights reserved.14-1 Learning Objectives 1.Use the percent of sales.
Ch. 10: Determining the Financing Mix How do we want to finance our firm’s assets? MF
Copyright © 2009 Pearson Prentice Hall. All rights reserved. Chapter 7 Leverage and Capital Structure.
McGraw-Hill/Irwin Copyright © 2007 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter Fifteen Cost Behavior, Operating Leverage, and Profitability.
Financial Projections Forecast—Budget—Analyze. Three Methods of Analyzing Financial Statements Vertical analysis Horizontal analysis Ratio analysis.
Ratio analysis The six major categories of ratios The du Pont Analysis Economic Value Added EVA 4-1 Financial Statements Analysis Tools Chapter 4.
25 seconds left….. 24 seconds left….. 23 seconds left…..
Financing and Valuation Principles of Corporate Finance Seventh Edition Richard A. Brealey Stewart C. Myers Slides by Matthew Will Chapter 19 McGraw Hill/Irwin.
PowerPoint Authors: Susan Coomer Galbreath, Ph.D., CPA Charles W. Caldwell, D.B.A., CMA Jon A. Booker, Ph.D., CPA, CIA Cynthia J. Rooney, Ph.D., CPA Copyright.
Chapter 10: Financial Plan 1 Copyright 2005 Prentice Hall Inc. A Pearson Education Company Creating a Successful Financial Plan.
Chapter 8 Cost-Volume-Profit Relationships. Introduction This chapter examines one of the most basic planning tools available to managers: cost-volume-profit.
Chapter 9: Financial Plan 1 Copyright 2002 Prentice Hall Publishing Company Creating a Successful Financial Plan.
Financial Statement Analysis. Common Financial Statements Balance Sheet Income Statement Statement of Retained Earnings Statement of Cash Flows.
1 Internal Analysis. 2 Lecture Topics Purpose of Internal Analysis Competitive Advantage and Core Competence Value Chain Financial Analysis Combining.
Does Debt Policy Matter? Principles of Corporate Finance Brealey and Myers Sixth Edition Slides by Matthew Will Chapter 17 © The McGraw-Hill Companies,
Chapter 8 Financial Plan Copyright 2006 Prentice Hall Publishing Company 1 Creating a Solid Financial Plan.
Creating a Successful Financial Plan Volume is vanity; profitability is sanity …Brad Skelton It is better to solve problems than crises …John Guinther.
Chapter McGraw-Hill/Irwin Copyright © 2008 by The McGraw-Hill Companies, Inc. All rights reserved. Operating and Financial Leverage 5.
Financial Management Unit – 2 Cost of Capital and Leverages.
Financial and Managerial Accounting Wild, Shaw, and Chiappetta Fourth Edition Wild, Shaw, and Chiappetta Fourth Edition McGraw-Hill/Irwin Copyright © 2011.
© 2016 SlidePlayer.com Inc. All rights reserved.