Post on 16-Nov-2020
transcript
LEVERAGE AND CAPITAL
STRUCTURE
Ms.S.VINOTHINI
ASSISTANT PROFESSORDEPARTMENT OF COMMERCE WITH CA
KONGUNADU ARTS AND SCIENCE COLLEGECOIMBATORE – 641 029
Leverage
Leverage refers to the effects that fixed costs have onthe returns that shareholders earn; higher leveragegenerally results in higher, but more volatile returns.
▫ Fixed costs are costs that do not rise and fall with changesin a firm’s sales volume. Firms have to pay these fixed costswhether business conditions are good or bad.
▫ Generally, leverage magnifies both returns and risks.
Capital structure is the mix of long-term debt andequity maintained by the firm.
Leverage (cont.)
• Operating leverage isconcerned with therelationship between the firm’ssales revenue and its earningsbefore interest and taxes(EBIT) or operating profits.
• Financial leverage isconcerned with therelationship between the firm’sEBIT and its common stockearnings per share (EPS)
General Income Statement Format and
Types of Leverage
Leverage: Operating Leverage
Operating leverage is the use of fixed operating costs
to magnify the effects of changes in sales on the firm’searnings before interest and taxes.
The figure on the following slide uses the data for
Cheryl’s Posters (sale price, P = $10 per unit; variable
operating cost, VC = $5 per unit; fixed operating cost,
FC = $2,500)
Leverage: Operating Leverage (cont.)
The degree of operating leverage (DOL) is the
numerical measure of the firm’s operating leverage.
As long as DOL is greater than 1, there is operating
leverage.
Leverage: Financial Leverage
Financial leverage is the use of fixed financial costs to
magnify the effects of changes in earnings before
interest and taxes on the firm’s earnings per share.
The two most common fixed financial costs are (1)
interest on debt and (2) preferred stock dividends.
Leverage: Financial Leverage (cont.)
The degree of financial leverage
(DFL) is the numerical measure
of the firm’s financial leverage.
Whenever DFL is greater than 1, there is financial
leverage.
Leverage: Financial Leverage (cont.)
A more direct formula for calculating the degree offinancial leverage at a base level of EBIT is thefollowing:
Note that in the denominator, the term 1/(1 – T)converts the after-tax preferred stock dividend to abefore-tax amount for consistency with the other termsin the equation such as interest expense.
The firm’s Capital Structure: Types of Capital
All of the items on the right-hand side of the firm’s balance sheet,
excluding current liabilities, are sources of capital. The following
simplified balance sheet illustrates the basic breakdown of total
capital into its two components, debt capital and equity capital.
The firm’s Capital Structure: Types of Capital (cont.)
• The cost of debt is lower than the cost of other forms of
financing.
• Lenders demand relatively lower returns because they take the
least risk of any contributors of long-term capital.
• Lenders have a higher priority of claim against any earnings or
assets available for payment, and they can exert far greater legal
pressure against the company to make payment than can owners
of preferred or common stock.
• The tax deductibility of interest payments also lowers the debt
cost to the firm substantially.
The firm’s Capital Structure: Types of Capital (cont.)
• Unlike debt capital, which the firm must eventually repay,
equity capital remains invested in the firm indefinitely—it has
no maturity date.
• The two basic sources of equity capital are (1) preferred stock
and (2) common stock equity, which includes common stock
and retained earnings.
• Common stock is typically the most expensive form of equity,
followed by retained earnings and then preferred stock.
• Whether the firm borrows very little or a great deal, it is
always true that the claims of common stockholders are riskier
than those of lenders, so the cost of equity always exceeds the
cost of debt.
THANK YOU
Ms.S.VINOTHINI
ASSISTANT PROFESSOR
DEPARTMENT OF COMMERCE WITH CA
KONGUNADU ARTS AND SCIENCE COLLEGE
COIMBATORE – 641 029
A lease is a contractual arrangement calling for the
lessee (user) to pay the lessor (owner) for use of an
asset. Property, buildings and vehicles are common
assets that are leased. Industrial or business
equipment is also leased.
Leasing has emerged as an important
source of long-term financing of
corporate enterprises during the recent
few decades.
LEASE AGREEMENT
The lease agreement sets
forth the period covered by the
lessee, provisions for payment of
taxes, insurances, maintenance
expenses and the like, provisions
for renewal of the lease or
purchase of the asset at expiration
and the timing and amounts of
periodic rental payments during
the lease period.
Financial Lease
Operating Lease
Conveyance Type lease
Leveraged Lease
Sale and Leaseback
Partial Pay-Out Lease
Consumer Leasing
Ballon Lease
Close end leasing
Swap Leasing
Wrap Leasing
Import Leasing
Cross Border leasing
International Leasing
TYPES OF LEASE
Financial Lease
Also called „Capital Lease‟A contract involving payment over an
obligatory period, of specified sums sufficient
in total to amortize the capital outlay , besides
giving some profit to the lessor.
ICAI defines it as : financial lease is a lease
under which the present value of the minimum
lease payments at the inception of the lease
exceeds or is equal to substantially the whole
of the fair value of the leased asset.”
It is non-cancelable in nature.
The lessee is responsible for the
maintenance of the asset leased.
The lease generally provides for the renewal
of the lease on expiry of the lease contract.
Variants : full payout lease , True Lease
An operating lease is a type of lease whereby
the asset is not fully amortized during the non-
cancelable period of the lease , and where the
lessor does not rely on the lease rentals for
profits.
Short term lease on a period to period basis.
Period of the lease is less than useful life of
the asset.
The lease is cancelable at short notice by the
lessee.
The lessee has the option of renewing the
lease after the expiry of the lease period
Asset maintenance and insurance etc. is the
responsibility of the lessor and he charges for
the same.
It is a high risk lease to the lessor, as any
time it may be cancelled by the lessee.
Net Lease :
A variant of operating lease, where the
lessor is not concerned with the repairs and
maintenance of the leased asset.
Lessor does not provide: - repairs,
maintenance, servicing of lease property -
purchasing parts and accessories. - loan of a
replacement/substitute - purchase of
insurance for the lessee.
Conveyance Type Lease :
Very long type of lease applicable toimmovable property.
Objective to convey the title inproperty.
Lease periods as long as 99 to 999years.
Leveraged Lease:
Where a financier is involved for thewhole or a part of the financial requirement.
Used for high value asset.
The financier will have charge over theleased asset, over and above the lease rentals.
Sale and Leaseback:
Owner of the asset sells it to the
lessor, and gets the asset back under the lease
agreement.
Ownership transfer from the original
owner to the lessor, who again leases out the
asset.
Immediate financing to the seller
company, whose funds are tied up in the asset.
Partial pay out lease:
Full payment of the lease in several
leases.
Consumer Leasing :
Leasing of consumer durables like
Refrigerator, televisions, etc.
Balloon Lease :
A lease which has zero residual value
at the end of the lease period. i.e. low lease
rentals at the inception, high in the mid years,
and low again at the end of the lease.
Close end leasing :
The asset is reverted to the lessor at
the end of the lease.
Open end leasing :
The lessee guarantees a minimum
value to the lessor , from the sale of the asset
at the end of the lease term. If on sale of the
asset, the residual value is less , then lessee
pays to the lessor the difference amount.
Import Leasing : -
Leasing of imported capital goods. -
beneficial to the lessee, because arranging
other sources of funds takes long.
Lenders do not usually finance the
import duty which forms sizable portion of the
cost. - during which the prices of imported
goods may rise + fluctuation in exchange rates
may happen.
Cross Border Leasing :
A lease where the lessor is in one countryand lessee in another.
The Jurisdiction of lessors and lessees arein two different countries.Eg. Leasing of airplanes.
International Leasing:
A case where the leasing company isoperating in various countries through itsbranches.
International leasing is active in countrieslike U.S., Japan, HongKong etc.