Leverage is linked with capital structure? Take example of a MNC and analyze.

Answer

Leverage: It is an advantage gained (it may be anything)

Leverage is linked with Capital Structure, since an organization having a optimum capital structure (where WACC (weighted average cost of capital) is minimum) is a great leverage/ advantage both to the company as well for the investors.

Organizations, generally have two types of risks; operating risks – impact of fixed costs & variability of EBIT & Financial risks – impact of interest cost/financial charges & variability of EBT.

Example:

XYZ ltd has the following nos:

Contribution – Rs.100 lacs, fixed cost – Rs.25 lacs, Financial Charges/debt cost – Rs.40 lacs.

Particulars	Value (Rs. In lacs)
Contribution	100
Fixed cost	25
EBIT	75
Interest cost	35
EBT	40

XYZ Ltd. has following:

Operating leverage	Financial leverage
Contribution / EBIT = 100 / 75 =  1.33	EBIT / EBT = 75 / 40 = 1.87

It is always preferable to have low operating risk & high financial risk (subject to Return on capital employed (ROCE) > Interest cost on debt funds)

We can conclude that, XYZ ltd (MNC) is having a optimum capital structure & manageable risk.