Leverage Case Study

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Recommended: Effectiveness of financial leverage

Introduction

Leverage refers to debt or to the borrowing of funds to finance the purchase of assets in a company. Business owners can use either debt or equity to finance or buy the company's assets. Using debt, or leverage, increases the company's risk of bankruptcy. It also increases the company's returns specifically its return on equity. Leverage is a key point for an investor or a firm because it helps them to invest or operate. However, it increases the level of risk. If an investor uses leverage to make an investment and the investment moves against the investor, his or her loss is much greater than it would've been if the investment had not been leverage. Leverage itself magnifies both gains and losses. In the business world, a company …show more content…

The relationship between contribution margin and earning before interest and tax (EBIT) is called degree of operating leverage. It may be defined as the rate of changes in EBIT due to the change in the rate of sales. The firm operating with high fixed operating cost has higher degree of operating leverage. Higher levels of risk are attached to higher degree of leverage. High operating leverage is good when sales are increasing and bad when they are …show more content…

Operating leverage is concerned with investment activities of the firm whereas financial leverage is concerned with financing activities of the firm. As well as this, operational leverage is determined by the cost structure of the firm but financial leverage is determined by the capital structure of the firm. Furthermore, degree of operating leverage enables us to measure the business risk associated with the firm. On the other hand, degree of financial leverage enables us to measure the degree of financial risk, associated with the

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