It is an analysis to study the impact /effect of the leverage. This could be studied through comparison of various financing plans of EBIT.
Among the various plans, we have to identify the best plan which has highest EPS over the others.
The firm which has highest EPS normally has least volume of fixed financial charge over the other firms.
What is meant by financial break even point ?
It is the level of EBIT to meet the fixed financial charge of the firm viz Interest on long term borrowings/Debentures and Preference dividend on Preference shares.
The following formula is used to compute the financial break even point for the firm to earn at least to cover the fixed financial charges of the firm:
Financial break even point= I + PD/1–t
The next analysis is nothing but Indifference point.
It is the point at which the EPS and EBIT are nothing but the same for two different financing plans known as the indifference point.
The indifference point could be found out through the following analyses:
The measures of the Financial leverage:
They are two in categories:
Stock Terms: The following are the two ratios viz debt equity ratio and debt + preference share capital to total capitalization ratio to measure the financial leverage.
Flow terms: The financial leverage means debt service ration and preference dividend coverage ratio to measure the capacity of the firm in meeting the periodical fixed financial commitments of the firm.
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