By leveraging, a firm is able to magnify the returns to the shareholders by using fixed cost bearing assets or funds. The fixed cost or interest acts as the fulcrum and the leverage magnifies the influence. The employment of an asset or source of funds for which the firm has to pay a fixed cost or interest has a considerable influence on the earnings available for equity shareholders. It shows the effects of the investment patterns or financing patterns adopted by the firm. The term leverage indicates the ability of a firm to earn higher return by employing fixed assets or debt. Therefore leveraging is the magnification of EBIT and the return of shareholders with appropriate mix of fixed and variable costs and debt-equity mix, respectively. A financing mix that maximizes shareholder’s earnings can be referred to as the appropriate capital structure mix. ![]() On the other hand, capital structure decisions involve an appropriate choice between the owner’s fund and the outsider’s fund. Cost structure decisions involve an appropriate choice of amount of fixed costs and variable costs.Ī mix of fixed and variable cost that maximizes EBIT is referred to as appropriate cost structure. Its cost is concerned with two important decisions: Cost structure decision and capital structure decision. Here comes the essence of leverage, because it is related to a profit measure, which may be a return on investments or earnings before taxes. This is done through magnifying the Earnings before Interest and Tax (EBIT) and the Earning per Share (EPS). ![]() The financial objective of every firm is to maximize value of the business and this can be done through maximizing profit or net present value.
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