Financial Leverage
Leverage refers to using borrowed capital to finance assets or investments, amplifying both potential returns and potential losses.
Concept map
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Definition
Leverage refers to using borrowed capital to finance assets or investments, amplifying both potential returns and potential losses.
Use case
Used in corporate finance workflows, analysis, and technical interviews.
Judgment check
Useful only when the assumptions and inputs behind the metric are understood.
⚡ Enterprise Value Calculator
Calculate the total value to acquire a company including debt and cash.
Deep dive
How to think about Financial Leverage
Operating leverage = fixed vs. variable costs. Financial leverage = debt vs. equity. Degree of Financial Leverage (DFL) = % change in EPS / % change in EBIT. Leverage magnifies ROE in good times but increases bankruptcy risk and interest burden. Optimal leverage balances tax benefits of debt against distress costs.
Example: Two identical $10M buildings: Investor A pays all cash. Investor B puts $2M equity, borrows $8M at 5%. If property values rise 20%, A earns 20%, B earns 100% (minus interest). If values fall 20%, A loses 20%, B loses 100% (equity wiped out).
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Enterprise Value provides the complete picture of acquisition cost. While Market Cap only reflects equity value, EV includes debt obligations and subtracts cash that the acquirer receives.
This metric is essential for comparing companies with different capital structures and is the standard for M&A valuation globally.