Levered equity

Definition

Levered equity is the portion of a company's equity that has been financed using debt. It reflects the increased risk and potential return associated with borrowing funds to invest in business operations.

5 Must Know Facts For Your Next Test

1. Levered equity increases both the potential returns and risks for shareholders due to the use of borrowed funds.
2. The cost of levered equity typically includes both the cost of debt and the required return on equity.
3. A higher degree of leverage can amplify earnings but also increases the company's financial risk, particularly in downturns.
4. Debt financing can provide tax benefits because interest payments are tax-deductible, which can lower the overall cost of capital.
5. Companies must carefully balance their capital structure to optimize levered equity without over-leveraging, which could lead to financial distress.

Review Questions

• How does levered equity affect a company's potential returns and risks?
• What are some advantages and disadvantages of using levered equity?
• Why must companies balance their capital structure when leveraging equity?

Related terms

Capital Structure: The mix of different forms of external funds used by a company, including debt and equity.

Cost of Debt: The effective rate that a company pays on its borrowed funds.

Financial Leverage: The use of borrowed money (debt) to amplify returns from an investment or project.