Global Initial Public Offers
Ever since the era of globalization, the world has started operating like one single market. The concept of a global village is often mentioned in the financial markets. This globalization has also had an impact on the investment banking business. Earlier, companies were limited to the stock markets of their home country when they wanted […]
Impairment in Sporting Franchises and Player Contracts
In the previous two articles, we have already established that the sporting industry has this unique practice of recognizing human players as intangible assets on their balance sheet. We also know that the value of these intangible assets is also routinely amortized just like other intangible assets. In short, the player contracts are treated exactly […]
The Importance of Personal Finance
There is no shortage of education in the field of finance. There are various academicians who work tirelessly in the field of finance. Many theories have been developed, and many conjectures have been disproved. Every year thousands of people graduate with finance as their major. However, most of these people are trained in the field […]
Advantages and Disadvantages of Freely Floating Exchange Rates
The freely floating currency system is the predominant system of foreign exchange that is prevalent in the world today. As globalization has progressed, more countries have abandoned their currency pegs and have allowed their currencies to freely float. Some have been forced to do so by market participants whereas others have made their choice in […]
Present Value and Future Value of Money
Value of Money Depends Upon Time In the previous article we learned about the concept of nominal and real values of money. We realized that money today is more valuable than the same sum received at a future date because there is no risk involved in obtaining it and also the real value of money […]
Most firms use both operating leverage and capital leverage to some extent.
In today’s business world it is almost impossible to run a business without having some degree of automation and mechanization (operating leverage). It is also not possible to grow at an adequate speed unless the company is taking advantage of borrowed money.
However, the degree to which a company uses operating leverage and financial leverage can be different.
Some companies use more financial leverage than operating leverage while other use more operating leverage. This creates a challenging scenario whereas an analyst has to interpret the different degrees of riskiness of companies with different cost and capital structures. The degree of combined leverage (DCL) makes it possible to do this.
PAT/Number of Shares = Earnings per Share (EPS)
Therefore if operating leverage of a firm= 1.4 whereas financial leverage = 2, then the degree of combined leverage equals 1.4 * 2 = 2.8
Degree of operating leverage shows how a change in sales affects the EBIDTA of the firm. Whereas degree of financial leverage shows how a change in EBIDTA affects the EPS of the firm. Combining the two analysts can predict how a change in sales is likely to magnify the gains or losses to the EPS.
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