Hi there,
In simple terms, financial leverage means debt for a return of investment. When the capital is borrowed for the growth and development of the firm's assets for generating returns on risk capital it is called financial leverage. I hope you are able to understand financial leverage meaning.
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I will share with you the process.
A company has three options for purchasing assets. The three types of options available are equity, debt, and leases. Besides, equity the options available incur fixed costs which are lower than the income which the company can earn. I will give you an example.
For instance, a company wants to buy an asset that costs Rs. 100,000. Now, the company can buy that by using the equity that is by sharing a part of the company. By doing this, a company can own 100% of the assets and no interest needs to be paid. If the value of the assets appreciates by 30% then the current value of the assets will be Rs. 130,000. This is how the company will earn 30% profit. In turn, if the value of the assets depreciates, then the company will run at a loss.
Alternatively, the company can use 50% of the common stock and take 50% debt. If asset value appreciates by 30% the value of the assets will be Rs. 130,000 and the company has to pay Rs.50,000 debt. So, the company will be left with Rs. 80,000. Similarly, if the value depreciates by 30% the value of the asset will be Rs.70,000. Meaning if the company pays Rs.50,000, the company will have Rs.20,000 remaining. I hope you understand what is meant by financial leverage.
This was all about financial leverage in a nutshell. I hope you find this informative.
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What is meant by financial leverage?
Nandini
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3 Year
2022-05-20T10:18:57+00:00 2022-05-20T10:19:00+00:00Comment
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