By Leverage effect (English "lever strength effect") the lever force of the financing expenses of the outside capital is understood on the own capital funds interest charges.

Calculation method

If the total capital net yield is higher rGK (internal interest rate of the investment) than the outside capital interest rate iS, the net yield increases rEK assigned own capital funds with increasing debt ratio V (relationship of stranger and own capital funds).

Under the premise that the outside capital interest rate is constantly also with high debt ratio, it applies the following formula:

r_ {EK} = r_ {GK} + V \ cdot (r_ {GK} - i_s)

Leverage Risk

The Leverage effect can cause meanwhile also negative effects on the own capital funds interest charges: If total capital profitability is under the interest of the outside capital, own capital funds profitability is reduced the more strongly, the more largely the portion of the outside financing of the total financing of the investment precipitates. This negative effect is called Leverage Risk.

To consider furthermore is, to which net yield possibly surplus or set free capital can be put on, if the Leverage effect is to be used.

Examples

Example 1

An enterprise can obtain a project with a net yield on the assigned capital (rGK) of 10 per cent. The entire assigned capital amounts to 1000 euro and by own capital funds and outside capital (thus ever 500 euro) was financed. The profit amounts to thus 100 euro. The fiber plastic interest, which the enterprise must pay to the fiber plastic giver, amounts to 2 per cent = 10 euro, there 500*2/100. The enterprise receives the remainder of the profit (90 euro). The net yield amounts to thus 18 per cent (90*100/500), since she gained this profit to the half from own capital funds.

The Leverage effect is the difference from net yield and interest expenditure, thus 90 euro (100-10) or 18 per cent on its assigned capital. Which that means, becomes in the example 2 clearly.

Excursion 1: The input clutch net yield (profitability) is smaller, since more EK (half) was available.

Example 2

The same enterprise (rGK 10 per cent, fiber plastic interest rate 2 per cent) reduces now the input clutch portion of the project from 500 euro to 200 euro. For the gap fiber plastic with the unchanged fiber plastic interest rate is responsible. Thus that amounts to fiber plastic now 800 euro.

From the unchanged profits of 100 euro now 16 euro (2*800/100) must be paid for interest. The remainder of the profit amounts to 84 euro, which input clutch capital eingesetzem with only 200 euro were gained. The input clutch net yield amounts to newly 42 per cent (84*100/200).

'' Excursion 2: The input clutch net yield (profitability) has itself because less EK was available, however the realization of profits the same is increased.

Example 3

Now we change the conditions for outside capital fundamentally! A interest rate from 12 per cent is sudden to to pay for the outside capital (before 2%). From the profit of 100 euro suddenly 96 euro (12*800/100) at fiber plastic interest are to be paid. For the enterprise 4 euro (100-96) remain, which corresponds to an input clutch net yield of only 2 per cent (4*100/200).

Conclusions

The basic assumption for example 2 is that the total capital net yield is larger than the fiber plastic interest rate. In such a constellation it is meaningful to replace own capital if possible by outside capital.

Otherwise it to be more meaningful to omit the investment and to put on the EK to fiber plastic interest (capital return e.g. by investment in securities). Because thus more yield would be gained and in addition no investment risk to exist. On this assumption it becomes clear that the lever effect plays only so long, as the fiber plastic interest is under the total capital net yield.

In example 3 it becomes clear that with more expensive outside capital or with breaking in net yield the total net yield can turn according to the lever also in negatives. This is the Leverage Risk.

Leverage effect at the option market

Similarly to the effects of the physical Hebelgesetzes this phenomenon makes possible for the option market participants to be received with small means relatively large positions in the base value. This means however also that the proportional change of the profits and losses on Terminkontrakten and options is larger than the appropriate change of the base value.

See also

• Modigliani Miller theorem

Articles in category "Leverage effect"

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