...Table of contents Contents i. Introduction to Leverage 3 ii. Significance of the Issue 3 iii. What is Leverage? 4 iv. Kinds of Leverage 4 a) Financial Leverage. 4 b) Operating Leverage. 4 c) Combined Leverage 5 v. Risks of Leverage 5 vi. Conclusion 5 vii. List of references 6 i. Introduction to Leverage In finance, Leverage is considered to be any financial instrument or loaned capital used to increase the potential return of an investment. Leverage is usually used in real estate and often in the automobile industry in the form of mortgage to purchase houses or vehicles. Leverage aids both the shareholder and the firm, but it comes with great deal of risk. If an investor makes use of leverage to create an investment and it doesn’t go in his or her favor, their loss is much larger than it would've been if they hadn’t used leverage. Leverage amplifies both gains and losses. In the business world, a firm is able to make use of leverage to try to produce shareholder wealth, but if it is unsuccessful to do so, the interest expense and credit risk of damaging the shareholder's value. Leverage can be used in many branches of finance including bonds, stocks, currencies, commodities and also other investments. Leverage can either be a good or bad thing for the firm depending on the situations that arise. ii. Significance of the Issue Leverage is one of the main topics in finance, one cannot study finance without coming across words like investments, loans, mortgages...
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...costs, and profits. | | | | |5-2. |What factors would cause a difference in the use of financial leverage for a utility company and an automobile | | |company? | | | | | |A utility is in a stable, predictable industry and therefore can afford to use more financial leverage than an | | |automobile company, which is generally subject to the influences of the business cycle. An automobile | | |manufacturer may not be able to service a large amount of debt when there is a downturn in the economy. | | | | |5-3. |Explain how the break-even point and operating leverage are affected by the choice of manufacturing facilities | | |(labor intensive versus capital intensive)....
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...COST BEHAVIOR: To get a better handle on cost behavior, what are some specific examples of variable, fixed, and mixed (semi-fixed) costs in our own personal lives. Great discussion and great examples! A great example how one thing can be variable, fixed, or semi-fixed depending on the choice of plan: My cell phone bill is an example of a fixed cost. The bill is always the same because usage always falls within the relevant range. The cost is predictable. An example of a variable cost rate would be a pay-as-you-go phone card where you pay for minutes in increments. No matter how many minutes I talk on my phone the bill remains the same. If I used a pay-as-you-go phone, the cost for each 100 minutes may be the same but my total cost would vary based on the amount of 100 minute increments I purchased. A semi-fixed cost would be a data plan on a cell phone where the price is fixed up to a point and then you pay incrementally for data blocks that are over your plan limit. To go a step farther, you can consider how your personal costs and income match up. Are most of your costs and income fixed? Then planning is easy. If you have fixed income, but many variable costs, watching those costs is crucial. Dealing with variable income, and a high proportion of fixed costs can also be challenging. A few points to remember: 1) In the long run, all costs can be variable (do we build that building?, do we hire that salaried employee?, do we rent that space?, etc.) 2) Don’t confuse the payment...
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...On Accounting Flows and Systematic Risk Neil Garrod University of Glasgow Dusan Mramor University of Ljubljana Address for correspondence: Neil Garrod, Department of Accounting and Finance, University of Glasgow, 65-71, Southpark Avenue, Glasgow G12 8LE, Scotland, U.K. Tel: 00-44-141-330-5426 e-mail: n.garrod@accfin.gla.ac.uk On Accounting Flows and Systematic Risk Abstract The body of work that relates accounting numbers to market measures of systematic equity risk was largely undertaken in the 1970s and early 1980s. More recent proposals on changes in accounting disclosure of risk mean that a rigorous theoretical model of the relationship between accounting measures and market measures of risk is timely. In this paper such a model is developed. In addition, the assumptions required to develop the model are explicitly identified. By so doing it becomes possible to identify the potential cross-sectional differences which drive the empirical relationship between accounting and market based measures of risk. The model developed highlights a clear relationship between accounting and market measures of risk which can be exploited in situations where accounting data alone is available. It also provides a framework within which the environmental factors leading to cross-sectional differences between companies can be further explored. On Accounting Flows and Systematic...
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...ASSIGNMENT #1 [pic] ASSIGNMENT #2 [pic] ASSIGNMENT #3 In terms of leverage, the Chinatrust is less risky than Metropolitan banks as evidenced by its higher Equity/Assets ratio and Equity/consumer Loans. As to liquidity, MetMetropolitan, on the other hand is more liquid since 45% of its total assets are earning assets as compared to Chinatrust’s 32%. ASSIGNMENT #4 Ayala Corporation has five industry segments where the Group operates: the Parent, Real Estate, Electronics, International and Automotives&Others. The parent company accounted for 20% of the consolidated revenues and 70% of the consolidated income. With very low opex, the Parent generates the highest operating profit at 90% and Net Profit margin of 70%. It is also the most efficient with the highest ROA among the segments. Real Estate segment contributed 30% of the consolidated income with an ROE of 10% and Net Profit Margin of 20%. The Electronics segment’s ROE and Net Profit Margin was almost zero despite its high revenues due to its large cost of opex. Electronics has many non-cash expenses, aside from the heavy depreciation which means it might have a good cash flow despite the very low Net Income. The Parent with 50% of the total assets financed by borrowings and Debt-Equity ratio of 1 is considered to be the most risky. On the other hand, the Automobile is the least risky with almost zero Debt/Asset and Debt/Equity Ratio. Ayala also presented its business segments on a geographical...
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...viewed as a result of an investment decision because if the current assets are less than its liabilities, the company may have a negative net worth (Block, Hirt, & Danielson, 2010). The degree of operating leverage or DOL is defined as the percentage change in the operating income that occurs as a result of a percentage change in the units sold (Block, Hirt, & Danielson, 2010). When a company is highly leveraged, they will have an increase in income as their volume expands. When the DOL is computed close to the break-even point it will result in a higher number because of the increase in the operating income (Block, Hirt, & Danielson, 2010). There are leveraged firms and conservative firms. The DOL for a leveraged firm is higher than of a conservative firm. This means that in this example, the Hi Tech Manufacturing Company would be considered to be more leveraged than that the Old School. Financial leverage is the amount of debt used in the capital structure of the firm (Block, Hirt, & Danielson, 2010). The text pointed out that it is helpful to remember that the operating leverage primarily affects the left-hand side of the balance sheet and the financial leverage primarily affects the right-hand side of the balance sheet. The degree of financial leverage or DFL is defined as the percentage...
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...Seagate Technology Buyout - Case Study Question 1: Why is Seagate undertaking this transaction? Is it necessary to divest the Veritas shares in a separate transaction? Who are the winners and losers resulting from the transaction? Answer: Seagate Technology was badly undervalued as far asSTOCK MARKET is considered, and due to this, the company decided to go for leverage buyout option. A large stake of VERITAS Software Corporation's stocks is owned by Seagate Technology, because of which its stock price is doubled (from its original price), however, the share price of Seagate Technology hardly changed for a long time. Therefore, the reason that the attempts and efforts of senior management were useless, made them decide to engage in Leverage Buyout (LBO). As a result, Seagate went for two fold transaction, i.e. the first is to sell out all of the company's disk drive manufacturing assets including $ 765 million of cash to the acquirer “Silver Lake”. On the other hand, the most crucial thing for Seagate Technology is to take care of the large stake of VERITAS Software Corporation's stocks. Therefore, it was essential for Seagate Technology to go for a separate transaction in order to evade paying large amount of taxes. The transaction of shares among VERITAS and Seagate is taken into account as reorganization of asset, while not applying any corporate taxes. Thus, by using two-fold transaction, Seagate Technology became able to liquidate its undervalued shares...
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...American Finance Association Limited Arbitrage in Equity Markets Author(s): Mark Mitchell, Todd Pulvino, Erik Stafford Source: The Journal of Finance, Vol. 57, No. 2 (Apr., 2002), pp. 551-584 Published by: Blackwell Publishing for the American Finance Association Stable URL: http://www.jstor.org/stable/2697750 Accessed: 08/01/2010 15:26 Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at http://www.jstor.org/page/info/about/policies/terms.jsp. JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at http://www.jstor.org/action/showPublisher?publisherCode=black. Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org. Blackwell Publishing and American Finance Association...
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...developed when e-commerce was in an infancy stage. This gave Amazon the opportunity to create and expand on the platform that we know today. It would prove to be very difficult if a similar firm were to try and duplicate the same success as Amazon. A similar firm would need to develop the credibility and reputation that Amazon has taken years to develop. Then it would need to establish a large client base that can bring together both buyers and sellers. One of the second major tools that a new firm would need to be competitive with Amazon is large amounts of capital. If a firm was to borrow capital the result would cause the company to become highly leveraged, which would mean that the margin of error would have to be very slim. High leverage a slim margin for error, thus in turn reduces pricing power and lowers profit margin. Within the past decade investment capital for online companies has become extinct sense the great boom of the .com era (Smith, 2015). This has left the playing fields wide open for venture capitalist seeking an opportunity for the next big thing. Within this paper we will...
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...book ratio where investors value Pepsi's balance sheet structure more than Coke. Pepsi is priced 5.5x of equity value compared to Coke which is priced only at 5x. Having a higher operating and profit margin, Coke is more likely to be able to sustain any shocks in the market (eg. from lower sales). The sustainability of Coke’s earnings are also helped by more efficient tax structure seen from lower effective tax rate compared to Pepsi. Its Selling General Administration expenses are also within the industry norm (compared to Pepsi). Coke’s has room to further improve its efficiency by improving its balance sheet structure. This includes a more efficient use working capital (eg. reducing receivables and inventory days), using higher leverage to attain higher return on equity and optimizing/sweating the assets more to generate higher asset turnover. Coke’s acquisition is substantially cashless. It exchanged $3.4bn of equity investment it had in CCE and assumed $9.5bn in debt and obligations to control CCE’s North American bottling operations. This will impact Coke’s financials in a few ways: i) With the acquisition, there could possibly be synergies and cost reduction which would benefit Coke’s bottom line. The resultant Coke’s earnings could improve with the consolidation of North American bottling earnings. This will then improve EPS....
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...appeal to the core readers. The very foundation of the business is therefore neglected * Rationale for the diversification strategy was a mitigate to cyclicality, but this clearly did not pay off. No clear evidence of alternative synergies between the businesses. Moreover, restructuring charges are substantial * Additional investment in declining trading cards business through the acquisition of SkyBox, while Marvel was already showing signs of distress * Drafting an unconvincing reorganization plan, which among others includes an additional acquisition (which raises new risk and debt in the short term). Selling off unsynergetic business units may have made more senses Bad execution * High leverage using overpriced shares as collateral. Given the this leverage in combination with relatively high coupon rates, debt service became problematic * Structuring debt based on collateral shares instead of others assets and cash flows makes a company highly dependent of debt providers in case of a covenant breach * Cash flow in a declining market is used for investments instead of deleveraging. Through SkyBox acquisition additional debt was taken on. Besides that,...
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...solid foot by 1980. The four year plan included steps to introduce fiscal discipline and maintain certain limits on debt to capital ratio, rating and fund raising activities. Also growth in hotel management fees and cash inflows from selling stakes in low return operations generated an excess amount of cash for the firm. The firm strongly believed in investing its cashflows as it believed in the operating model and the fact that investors would gain higher returns than if dividends were paid out. This higher cash inflow led to reduced need to raise debt. Also this excess cash could be used to pay down outstanding debt (expected to be $125 million by 1883). On the other hand the firm’s equity value was rising and this led to a declining leverage ratio. The management of the company believed that its expertise was in hotel development and management and not in long term hotel ownership. The strategies they designed were based on these factors and they started producing excellent results. In 1980 the growth prospects looked great, especially when compared to its competitors. While its peer companies had stopped growing in businesses they owned and grew very selectively in those they managed without owning, the independent companies weren’t even able to obtain financing for their planned expansion. Marriott wanted to make use of their advantage in position to accelerate their hotel room growth to 20%-25%. Their management contracts earned them a minimum constant percentage of...
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...ACCT 7340 Fall 2013 Professor Lin Solution to Individual Assignment 8 (1) The cost of equity is calculated as follows. Whirlpool: ........................... IBM: ..................................... Target Stores: ...................... 3.5% + (2.27 x 5.0%) = 14.85% 3.5% + (0.78 x 5.0%) = 7.40% 3.5% + (1.20 x 5.0%) = 9.50% (2) We use the book value of the debt and the market value of the equity as the proxies for the intrinsic values of debt and equity, respectively. Whirlpool 2,597 46.7% 2,959 53.3% 5,556 100% IBM 23,925 17.7% 110,984 82.3% 134,909 100% Target Stores 21,752 49.1% 22,521 50.9% 44,273 100% IVd IVe IVf Weighted Average Cost of Capital: Whirlpool: ........................ IBM: .................................. Target Stores: ................... (.467 x .65 x 6.1%) + (.533 x 14.85%) = 9.76% (.177 x .65 x 4.3%) + (.823 x 7.40%) = 6.58% (.491 x .65 x 4.9%) + (.509 x 9.50%) = 6.40% Note that Whirlpool has the highest weighted average costs of capital because it has the highest cost of both debt and equity. However, this does not mean firms with higher cost of debt and higher cost of equity will always have higher WACC. Look at the comparison between IBM and Target. IBM has the lower cost of debt and equity than Target. However, IBM has least leveraged capital structure (Debt-to-Equity ratio= .177/.823 = 0.216) while Target has the most leveraged capital structure with Debt-to-Equity ratio = 0.966. The extremely high portion of equity capital in IBM...
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...Homework 1: Part 1: H Partners and Six Flags Case Study. Following questions are based on the case study. 1. Briefly describe the reasons for Six Flag’s deteriorating performance. Do you believe the core business is sound? (Note-I am not looking for a very long answer. The reasons for bankruptcy will play a big role in your decision to invest or not invest in a company. For instance: a business cycle downturn vs new research that shows company’s products are harmful for people (think asbestos)) Due to the volatile state of Six Flags between 2003 and 2009, one could conclude that Six Flag’s business model was not financially sound. In looking at comparable firms such as Disney or Universal Studios, the amusement parks are not their only component in their business model. In addition to being poorly diversified, Six Flags sold tickets at steep discounts and heavy promotions, which drove the average ticket price to $21.10 in 2008. Unlike their competitors, the parks are marketed to consumers within 100 miles of the park. Firms like Disney and Universal have both domestic and international tourists, the majority of which come from more than 100 miles away. This leaves Six Flags with limited same-park growth because they are limited to the population within driving distance to the park. Furthermore, an unfortunate sequence of events hit the company in 2009. The outbreak of the H1N1 (swine flu virus) caused the Mexico City park to shut down and negatively impacted...
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...Sensitivities? What happened to the gross margins? Willing to use these projections for valuation? Car Wash Partners Management Tom Curtis – successful entrepreneur from the past. Credible? Curtis capable of leading major change in this industry? No further management team as yet Investors Cabot Brown (Brown & McMillan) Start up-VCs? First deal Who are their investors? Bill Burgin (Bessemer Partners) Experienced VC Investing with a friend? Does the investment fit their needs? Car Wash Partners Valuation Who puts up the money? (BMC, Bessemer; total of $6.6) How much is Curtis’ contribution worth at this stage? The “pre-money” value ($1.1; “post-money” value ($7.7, see Exh 9). VCs had 86% of capital) P/EBITDA 1997 (Exh 6); assuming 50% leverage P = $7,700 EDITDA = $629 Ratio = 12.2x In 2001: EBITDA = $50,192 (Increase due to 45x growth in revenues; 1.8x growth in CF margins) ROI = $18.8/$142 = 13.2% (after $135 of new equity financing) In 2001, at Exit via IPO at EBITDA x 12 = $600 million X 15% = 90 4yr ROI = EBITDA x 10 = 500 75 P/E of 25 = 470 70 P/E of 15 = 282 42 85% 77 74 53%...
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