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Objective To understand the concept of leveraging.
What effect does it have on the capital structure of the company.
Purpose of leveraging.
Effect of beta of leveraging firm for decision making.
Lastly analysis of the industry in order see how beta helps in decision making of levered and unlevered firm.
Meaning : leverage
Leverage or financial leverage is the use of funds, such as debt and preference capital along with owners equity in the capital structure.
Financial leverage employed by the company helps in earning more return on fixed charge rather than their cost.
Measure of financial leverage
Debt ratio
Debt equity ratio
Interest ratio
How leveraging effect company
Unlevered(All Equity)
Levered(Debt Equity)
EBIT 1,20,000 1,20,000
Less interest (31.25%)
0 37,500
PBT 1,20,000 82,500
Less taxes (50%) 60,000 41,250
PAT 60,000 41,250
Total Earning (PAT + INT)
60,000 78,750
No. of ordinary shares
50,000 25,000
EPS 1.20 1.65
ROE 12% 16.5%
Beta Beta is the mode of measuring risk.It is being used in financial market more
often in order to ascertain the returns. In the valuation term it can be defined as
variance that cannot be mitigated by the diversification of the portfolio.
Beta can be estimated for individual companies using regression analysis against a stock market index.
Determinants of BETA
Type of business
Degree of operating leverage
Degree of financial leverage
Allen candy inc.
Privately owned firm in Delaware.
Specialized in candy making.
Wants to go public
Wants to find the cost of equity in both cases when company will be levered or unlevered
Finding the beta food processing industry less than 250
million Market capitalisation is taken. Regression beta 0.98Average debt to equity is 43%(30-70 debt
equity)Tax is assumed on an average to be 40%Risk free rate is 4.50%Risk premium is 4%
Beta of levered=Beta of unlevered(1+(1-tax)Debt/Equity)
Unlevered beta 0.98/(1+(1-0.4)(30/70))= 0.78
Total unlevered beta =market beta/sqrt R-squared
0.78/sqrt .1112= 2.34
Since we have unlevered beta so levered beta is 0.98
0.78(1+(1-0.4)(30/70))
Cost of equity = 4.5%+0.98(4%)=8.42%
Total beta 2.34(1+(1-0.4)30/70)=2.94
Cost of equity= 4.5%+2.94(4%)=16.26%
Conclusion These two beta represents the two
dimensions for investments.Levered beta and cost ascertains talks of the
cost and risk which is to be kept in mind by the institutional investors when co. comes with IPO in the market.
Unlevered beta talks of individual investors who plan to invest all the wealth in this company..
Presented by Varun Kumar Bachhawandia Mohit YadavRaghav VashistSaurabh Kamra Vinod Kumar Meena Mandeep Singh