The Decline of the Big Corporation
The era of big corporations started during the industrial revolution. The past couple of centuries have witnessed the rise of these mega-corporations, particularly in the developed western world. In many cases, these corporations have become extremely powerful and have behaved aggressively with weaker nation-states as well. The idea that some private individuals can amass more […]
Getting Creative with Capital Budgeting
From the past few articles, it may seem like capital budgeting has a pre-determined procedure. All the possible scenarios that can occur have been thought of and appropriate solutions for all of them have already been developed. While this makes “capital budgeting” a good subject, it also removes the creativity from it. There is a […]
What is a Revenue Model?
Modern-day start-ups can be of many different types. They can be differentiated on the basis of several parameters. One of the parameters which are used for such differentiation is called the revenue model. Many people confuse the term revenue model with the more commonly used business model. In this article, we will have a closer […]
Calculating Free Cash Flows: The Case of Preferred Shares
In the previous few articles we understood how to calculate free cash flows which accrue to the firm as a whole as well as to equity shareholders. However, while conducting this analysis we made an implicit assumption. We assumed that there are only two classes of funds available to the firm, this is equity and […]
Price to Book Value Ratio – Formula, Meaning, Assumptions and Interpretation
Formula Price to Book Value = Current Market Price / Total Assets – Intangible Assets The value of assets is taken from the most recently published balance sheet. Meaning The price to book value ratio looks at an immediate liquidation scenario. Investors therefore compare the price that they are paying for the company against what […]
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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