Capital
budgeting
Capital budgeting is the process of decision to
invest the capital funds long term investment planning or it is the process of
accruing the long term assets.in
leverage
The term leverage may be defined as the acquisition
and employment of an assets or source of fund for which the firm has to pay
fixed cost or fixed return. the ability of firm to utilize such fund efficiently
which results in maximization of the shareholders return is also covered by the
term leverage.leverage also facilitates the appropriate section of sources of
fund among the various alternatives available.
Types
of leverage
a.operating
leverage : degree ofoperating leverage is the relationship between firms
percentage change in sales and percentage changein operating profit.the
leverage associated with the employment of an asset for which a firm has to pay
fixed cost may be termed as operating leverage. Occurs leverage occurs due to
fixed operating cost.if a firm use high fixed cost has higher operating
leverage and also operating profit increase.
B .financial
leverage :degree of financial leverage is the relationship between
percentage change in earning per share and percent change in EBIT. financial
leverage is related to the financing activities of a firm. The sources of fund
can be categorized into fixed return source and variable return of sources.
Fixed return sources of capital includes bank loan, debenture and preference
shares. The firm having more debt and preference share capital in its capital
structure has higher degree of financial risk and greater amount of risk.
C. combined
leverage :the combination of operating and financial leverage is called
total or combined leverage. operating leverage measures the operating risk
whereas financial leverage financial risk. Total leverage measure the total
risk of the business. Combined leverage is the relationship between percentage
change in earning per share and percentage change in sales.
Indifference
point of EBIT
Different financial plan show different level of
earning per share (EPS). A company must choose the financial plan having
highest eps to maximize the return to shareholders .Indifference point of EBIT
is that amount of EBIT at which both financial plans will be equally beneficial
to the company.at the level of indifference point, the company is in situation
of choosing either the plan because both plan have equal EPS.
