Introduction to Capital Structure and Leverage

Capital Structure

  • A firm’s capital structure represents its mix of capital sources, i.e. its mix of debt financing and equity financing.
  • In theory, companies should seek an optimal capital structure with the objective of minimizing the cost of capital.
  • The cost of capital is typically its weighted average cost of capital (WACC), applying the marginal cost of debt financing and equity financing.  Since interest is typically a tax deductible expense, the WACC calculation will incorporate the after tax cost of debt.

Leverage

  • Leverage is the utilization of fixed costs by a company.
  • Leverage can be operating (fixed assets that depreciate) or financial (debt).
  • While financial leverage and operating leverage can amplify earnings during periods of growth, they can also increase the risk of financial distress during periods of economic decline.
  • Financial leverage exposes a company to financial risk.
  • The degree of financial leverage (DFL) can be calculated as:

DFL = EBIT/EBTWhen a firm has no debt, EBIT = EBT, so DFL will = 1.  Upon assuming debt, a firm’s DFL will increase above 1.

  • Another method of considering financial leverage is a company’s debt to equity ratio.

Data Science in Finance: 9-Book Bundle

Data Science in Finance Book Bundle

Master R and Python for financial data science with our comprehensive bundle of 9 ebooks.

What's Included:

  • Getting Started with R
  • R Programming for Data Science
  • Data Visualization with R
  • Financial Time Series Analysis with R
  • Quantitative Trading Strategies with R
  • Derivatives with R
  • Credit Risk Modelling With R
  • Python for Data Science
  • Machine Learning in Finance using Python

Each book includes PDFs, explanations, instructions, data files, and R code for all examples.

Get the Bundle for $29 (Regular $57)
JOIN 30,000 DATA PROFESSIONALS

Free Guides - Getting Started with R and Python

Enter your name and email address below and we will email you the guides for R programming and Python.

Data Science in Finance: 9-Book Bundle

Data Science in Finance Book Bundle

Master R and Python for financial data science with our comprehensive bundle of 9 ebooks.

What's Included:

  • Getting Started with R
  • R Programming for Data Science
  • Data Visualization with R
  • Financial Time Series Analysis with R
  • Quantitative Trading Strategies with R
  • Derivatives with R
  • Credit Risk Modelling With R
  • Python for Data Science
  • Machine Learning in Finance using Python

Each book comes with PDFs, detailed explanations, step-by-step instructions, data files, and complete downloadable R code for all examples.