Fundamentals of Financial Management, Third Edition

21.3 FINANCIAL LEVERAGE

Financial leverage has already been explained at greater length in Chapter 14. The readers are requested to go through it in that chapter. Based on the discussion in Chapter 14, financial leverage is different from the operating leverage:

• Operating leverage influences the operating income. Financial leverage influences the EBT.
• Operating leverage is concerned more with the production activities. Financial leverage is concerned with the financing decision.
• Operating leverage normally involves the business risk. Financial decision involves the financial risk.
• The degree of operating leverage depends upon the size of fixed cost. The degree of financial leverage depends on the size of debt in the capital structure.

Financial ...