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Analysing an impact of the financial leverage on the return on equity
Języki publikacji
Abstrakty
Relation between a company's capital borrowed and the value of its total equity is termed as the financial leverage or gearing. There are at least several reasons why the aggressive use of debt may have a very positive influence on productivity and market value of companies. First of all, debt is less expensive form of financing than equity because interest expense is tax-deductible whereas dividend payments are not. When the debt is substituted for equity, the overall amount of capital used in a business will not change nor will the total rate of return needed to compensate investors for bearing the firm's business risk. If the rate of return on assets financed by borrowing is greater than the cost of the debt, any surplus is added to equity earnings, and thus benefits the ordinary shareholders. The other side of the coin is that debt interest must be met, even if the rate of return on assets is less than the rate of debt interest. In that event, the net result is a loss from borrowing. The paper presents simple ways of measuring an impact of financial leverage on the return on equity. Examples without income taxes and with taxes have been provided. The genera] conclusion of the paper is that debt ought to be used in a prudent way. Unfortunately, there is no satisfactory theory saying at what level of leverage (gearing) there is "too much" debt.
Czasopismo
Rocznik
Tom
Strony
225--237
Opis fizyczny
bibliogr. 1 poz., tab.
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autor
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Typ dokumentu
Bibliografia
Identyfikator YADDA
bwmeta1.element.baztech-article-BUS6-0003-0018
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