07 Capital Structure
Capital Re-Structuring¶
Change in capital structure and leverage
If we need to keep assets constant, then inc in debt should be accompanied with purchasing shares
We can maximize shareholder wealth by decreasing WACC
Leverage¶
| Operating Leverage | Financial Leverage | |
|---|---|---|
| Asset for which firm has to pay a fixed cost | Source of funds for which firm has to pay a fixed return | |
| Shows ability of firm to | Use fixed costs magnify effects of change in sales on its EBIT | |
| Relationship between | Sales & EBIT | |
| Formula | \(\frac{\Delta \% \text{EBIT}}{\Delta \% \text{Sales}}\) | |
| We employ assets with fixed costs in the hope that volume will provide revenues sufficient to cover all fixed & variable costs | ||
| Interpretation | If you believe that you can increase your sales by investing, go for investing in fixed costs | |
| Risk | Operating risk | EBIT & EPS |
| Preferred for | Companies with steady expansion | |
| Liquidity \(\propto \frac{1}{\text{Operating Leverage}}\) |
Fixed cost is a cost that does not change with no of units.