What is exactly leverage? I know that financial leverage = equity mulitpler = assets/equity Is financial leverage same as just leverage? Or debt/equity is leverage? I remember seeing a question that what happens to leverage and stock holder’s equity if company increases dividends . Any comments on it? I know stock holder’s equity will be lower. Wondering on financial leverage.
you have financial leverage which is same as equity multiplier that is assets/equity - the one you use in roe dupont formula and there is operating leverage -which is delta % in earnings/delta% sales and then you have total leverage = dol * dfl that is total leverage= fin lev* operatin lev
I guess the easiest way is to look at it as a lever, which essentially measures risk. When you load a company up with debt, you have a higher interest expense, lower taxable income, relatively more earnings available to equity holders, all else remaing the same, ie. you keep making a profit. A large or relatively material dividend payment will decrease cash, and decrease retained earnings, which makes your leverage ratios increase. You could also take out a loan to buy back stock or issue a dividend to do the same thing. On a conceptual level, increasing debt will increase value due to tax shields, lower WACC, and the thought that you know you have to make interest payments and will focus on operations that create cash. Companies can screw with ROE this way also, which is why most every ratio is usefull only as a comparable. Too, 1 + D/E = Equity multiplier Hope this helps.
jsut remember guys, assets/equity is NOT financial leverage… its the financial leverage multiplier… financial leverage is the (%change net income) / (%change EBIT) remember that the meaning of financial leverage is that as you increase your fixed intrest costs, a small change in operating earnings (EBIT) leads to a GREATER change in NET INCOME
If financial leverage to be used is NOT Assets/equity, what do you use to find how dividends affect leverage of company? I guess by giving dividends, both numerator and denominator of Assets/equity will decrease, causing lower number? Am I correct?
ahhh you’re right, but i meant, financial leverage is not the same as financial leverage multiplier, in terms of their definitions… like, if the question were to ask you, what is the financial leverage, as opposed to, what is the financial leverage multiplier… (someone correct me if im wrong)