what is the meaning of Leverage Effect in case of valuation of Goodwill?what it means when it is said that the leverage effect is adverse/favourable in case of valuation of G/W?Plzz..reply soon...
CA Dhiraj Ramchandani
(CA, M. com)
(10823 Points)
Replied 24 December 2009
MEANING OF LEVERAGE EFFECT IN NORMAL TERMS :
The leverage effect explains a company’s return on equity in terms of its return on capital employed and cost of debt. The leverage effect is the difference between return on equity and return on capital employed. Leverage effect explains how it is possible for a company to deliver a return on equity exceeding the rate of return on all the capital invested in the business, i.e. its return on capital employed. When a company raises debt and invests the funds it has borrowed in its industrial and commercial activities, it generates operating profit that normally exceeds the interest expense due on its borrowings.
CA Dhiraj Ramchandani
(CA, M. com)
(10823 Points)
Replied 24 December 2009
Now, in case of goodwill.... For calculation of leverage effect, two goodwill amounts are calculated :
1. GOODWILL FOR SHAREHOLDERS
2. GOODWILL FOR FIRM (incl. shareholders as well as long term debt providers)..
Now, if GOODWILL FOR SHAREHOLDERS is greater than that of FIRM, that means leverage is positive, because, shareholders are able to gain more than the FIRM overall.... And leverage is considered unfavourable in vice-versa condition
CA Dhiraj Ramchandani
(CA, M. com)
(10823 Points)
Replied 24 December 2009
so, in short....
WHEN RETURN ON ASSETS (FOR SHAREHOLDERS) exceeds COST OF DEBT, the leverage is considered as favorable.... and vice-verca..
CA Dhiraj Ramchandani
(CA, M. com)
(10823 Points)
Replied 25 December 2009
Ur welcome s jain...
regards
DHIRAJ
nisha
(student)
(50 Points)
Replied 09 May 2011
sir,
what is mean of leverage effect in the company.....
if leverege effcet is adverse/ favourable its impact on the company...??????????
LIVE Course on Foreign Exchange Management Act (FEMA)(with recording)
LIVE Form 10 B and Form 10BB: Handle Tax Audit Reports of Charitable Organizations(with recording)