Leverage (finance)

This product was added on the quality assurance side of the portal business arising from the substantive and / or formal defects. You can help by you are removing the deficiencies mentioned there or you engaged with any of the discussion.

The leverage effect ( [li ː vəɹɪdʒ ]; . Engl for leverage / leverage) is a financial economic term that generally describes situations where small changes of variables lead to large fluctuations in the result. The term leverage is in the areas of ( i) capital structure (financial leverage ), ( ii) the cost structure (operating leverage ) and used in ( iii ) derivatives.

• 2.1 implication

Capital structure

As leverage the leverage of financing cost of debt is understood on the return on equity. So can be increased by use of leverage, the equity return on an investment. However, this only applies when an investor may borrow on more favorable terms than the investment made ​​to return on total capital.

Calculation method

If the return on total capital RGK ( Internal rate of return of investment) is higher than the borrowing rate RFK, the yield increases with increasing levels V ( ratio of debt and equity ) rEK on capital employed (also called equity ).

Under the assumption that the borrowing rate is constant even with high leverage ( FK / EK ), the following formula applies:

Leverage risk

With increasing debt ( leverage ) can also contain minor variations of the interest on borrowed capital or the overall profitability of the project generate sharp swings in the return on equity.

Example 1

A company can achieve in a project a return on capital employed (RGK ) of 10%. The whole investment is € 1,000 and was in half by equity and debt capital (ie € 500 ) financing. Earnings before interest thus amounts to 100 €. The FK- interest, the company must pay the FK- donor, equivalent to 2 % (500 € * 0.02 = ) 10 €. The profit (90 € ) is replaced by the company. The return on equity is thus 18% ( € 90 / € 500), since this profit was earned half of equity.

The leverage effect is the difference between yield and interest expense, or 90 € ( € 100 - € 10) or 18 % on the capital employed.

Example 2

The same company (RGK 10% borrowing rate RFK 2% ) now reduces the EK- share of the project from 500 € to 200 €. For the gap FK comes on with the unchanged FK- rate. Thus, the FK now is 800 €.

From the unchanged Rohgewinnen of 100 € must now be paid for interest 16 € ( € 800 * 0.02). The rest of the profit is 84 €, which were generated with only 200 € EK- employed capital. The return on equity is 42% new (84 € / 200 €). The vacated € 300 ( € 500 from Example 1) must now also be applied at least to the FK- rate to the gap of the absolute gain (6 € = 90 € - 84 € = € 300 * 0.02) to compensate.

Example 3

Now we change the conditions for borrowing fundamental - is a sudden for the borrowing interest rates of 12 % to be paid (previously 2%). From the gross profit of 100 € 96 € ( € 800 * 0.12 ) are suddenly to be paid on FK- interest. For the company remain € 4 ( € 100 - € 96 ), which corresponds to a return on equity of only 2 % (4 € / 200 €).

Conclusions

The basic assumption for Example 2 is that the return on assets is greater than the FK- rate. In such a situation it is useful to replace private capital as possible by debt. You can deduct the interest paid from the taxes also know what an additional tax benefit from debt is the result ( tax shield). Interest rates mean effort, this reduces the profit, which must be taxed. This has been neglected in the above examples.

If the return on assets would be less than the interest rate on debt, then it would be better to refrain from the investment and to create the EK to FK - interest ( interest on capital, for example through investment in securities ). This more income would be generated and also made ​​no investment risk. Under this assumption, it is clear that the leverage effect only as long as a positive effect, as the FK- interest is less than the return on assets.

From Example 3 shows that with more expensive debt or slumping return the total return can turn into negative according to the lever also.

Cost structure ( operating leverage )

A similar leverage as the (fixed) interest on the (variable) return on equity effect exists between the fixed costs and the return on sales. Following the financial leverage effect here of operating leverage (also profit lever ) is spoken; the profit lever

• Measures the relationship between the fixed and variable costs of a company,
• Is greatest in firms with high fixed costs and low variable costs
• Shows how a percentage change in sales volume will affect the profit.

From operational fixed costs resulting leverage effect on the total costs of the company ( fixed costs plus variable costs). The fixed costs increase the profitability of business operations and high utilization, but involve in bad business as well as low utilization significant risks, since the fixed load remains. The production of an inherent fixed costs thus cause a disproportionate impact of revenue fluctuations on net income.

Due to a change in sales volume.

• X: Current sales volume ( single-product )
• P: revenue per unit
• Kvar: Variable costs per unit
• Kfix: Fixed costs

Example: Company A and Company B

Implication

The relative EBIT of Company A is more sensitive than that of the company B to changes. Therefore, Company A has a higher return variability compared to company B. In connection with the estimation of the beta factor in the technical fundamental analysis it can be concluded that his needs.

Leverage effect of derivatives

Even with derivatives is spoken by lever or leverage, since relatively large positions in the underlying asset may be entered into with small means. This means that the percentage change in profits and losses on a derivative is greater than the corresponding change of the respective Underlying.

With lever is usually meant in this context, how many warrants can buy an investor for the current price of the respective Underlying. He therefore results from dividing the current price of the option by the current price of the underlying. The option relates to a multiple or fraction of the Underlying, this factor must be taken into account in the calculation. This is referred to by the subscription ratio.

He is not in this sense, by how much an option to purchase (call) or put option ( put) goes up in value when its underlying more expensive or less expensive by one percent. Thus, it is only a measure of the level of investment of the investor. The conventional lever term corresponds rather the Omega measure, which is therefore also called effective lever. Mathematically, this corresponds to the product of Omega Delta and lever.