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Leverage effect

ANJALI NEGI (Chartered Accountant) (1263 Points)

19 October 2012

Hellp everyone,

Can anyone explain me the concept of Leverage effect while calculating Goodwill??? When this effect occurs and why??

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(Guest)

Leverage affect is the affect which is occured due to Debts. Due to debt the Capital Employed of the company changes and the interest in such debt alters the profit which automatically cahnges the value of goodwill.

In short, The amout of debt is also considered while valuing the company whether to aquire the company or its shares. As the debt is liability, it is considered to know the synergy..

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ANJALI NEGI (Chartered Accountant) (1263 Points)
Replied 19 October 2012

Thanks But can u explain me this with practical example..i would be thankful to u.

(Guest)

Leverage affect means " G/wll(debt considered as debt)-G/wll(debt considered as capital)

Suppose your Balance Sheet shows Debt @ 10%= 100, C.liab= 50 and Total assests= 250 and FMP=25 NRR=10%

G/wll(debt considered as debt)

Then To calcultate g/wll you need to calculate Capital emplyed which comes as 250-50-100= 100.

calc. G/wll : 25/10% -- 100 = 50

G/wll(debt considered as capital)

Then To calcultate g/wll you need to calculate Capital emplyed which comes as 250-50= 200.

From capital emplyed debt is not deducted as debt is considered capital. Simply saying We want to calculate goodwill where we assume the company is debt free..

As debt isnot considered to calc g/wll so we have to takeout the interest part from the profit. so add back interest(net of tax). FMP:- 25+10=35

G/wll: 35/10% -- 200= 150

Summary: Simple Language main: Goodwill ka Value Kitna Hoga agar company debt main hain ya debt mai nahi hoga.. & Leverage affect means How much the value changes considering the both cases.

It is also called TRADING ON EQUITY. I hope you remember the PCC/IPCC theory of Costing & FM

Hope you understood.

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