Objective

To understand the concept of leveraging.

What effect does it have on the capital structure of the

company.

Purpose of leveraging.

Effect of beta of leveraging firm for decision making.

Lastly analysis of the industry in order see how beta

helps in decision making of levered and unlevered firm.
Meaning : leverage
Leverage or financial leverage is the use of
funds, such as debt and preference capital
along with owners equity in the capital
structure.

Financial leverage employed by the company

helps in earning more return on fixed charge
rather than their cost.
Measure of financial
leverage
Debt ratio

Debt equity ratio

Interest ratio
How leveraging effect Unlevered Levered

company
(All Equity) (Debt Equity)
EBIT 1,20,000 1,20,000
Less interest (31.25%) 0 37,500

PBT 1,20,000 82,500

Less taxes (50%) 60,000 41,250
PAT 60,000 41,250
Total Earning (PAT + 60,000 78,750
INT)
No. of ordinary shares 50,000 25,000
EPS 1.20 1.65
ROE 12% 16.5%
Beta
 Beta is the mode of measuring risk.
It is being used in financial market more often
in order to ascertain the returns.
In the valuation term it can be defined as
variance that cannot be mitigated by the
diversification of the portfolio.
Beta can be estimated for individual
companies using regression analysis against a
stock market index.
Determinants of BETA
Type of business

Degree of operating leverage

Degree of financial leverage

Allen candy inc.
Privately owned firm in Delaware.

Specialized in candy making.

Wants to go public

Wants to find the cost of equity in both cases

when company will be levered or unlevered
Finding the beta
food processing industry less than 250 million
Market capitalisation is taken.
Regression beta 0.98
Average debt to equity is 43%(30-70 debt
equity)
Tax is assumed on an average to be 40%
Risk free rate is 4.50%
Risk premium is 4%
Beta of levered=Beta of unlevered(1+(1-
tax)Debt/Equity)

Unlevered beta
0.98/(1+(1-0.4)(30/70))= 0.78

Total unlevered beta =market beta/sqrt R-squared

0.78/sqrt .1112= 2.34

Since we have unlevered beta so levered beta
is 0.98

0.78(1+(1-0.4)(30/70))

Cost of equity = 4.5%+0.98(4%)=8.42%

Total beta
2.34(1+(1-0.4)30/70)=2.94

Cost of equity= 4.5%+2.94(4%)=16.26%

Conclusion
These two beta represents the two
dimensions for investments.
Levered beta and cost ascertains talks of the
cost and risk which is to be kept in mind by
the institutional investors when co. comes
with IPO in the market.
Unlevered beta talks of individual investors
who plan to invest all the wealth in this
company..
Presented by
Varun Kumar Bachhawandia
Mohit Yadav
Raghav Vashist
Saurabh Kamra
Vinod Kumar Meena
Mandeep Singh