Leverage is the use of borrowed money to enhance the returns of any investment. Using leverage, an investor is able to achieve the returns of a very large investment whilst only providing the capital for a small investment. Unfortunately, as well as enhancing returns leverage will also magnify losses. An example of the pros and cons of leverage is below:
- A hedge fund has $10 million of its own money
- In year 1, the fund has a good year and returns 10%, or a $1 million profit
- This is a 10% return on equity ($1,000,000 / $10,000,000)
- In year 2, the fund borrows $90 million in the money markets and has to pay $5 million per year to service the debt
- The return in year 2 is 10% again, or $10 million
- After subtracting the $5 million to service the debt, total profit is $5 million, which is 50%, return on equity ($5,000,000 / $10,000,000)
- Simply by using borrowed money, the fund has increased its returns from 10% to 50%
- In year 3 the market turns against the fund, and they experience a loss of 10%
- This is a loss of $10 million, plus the $5 million to service the debt, which is a total cost of $15 million. This is more than the $10 million of equity in the fund, so it is bankrupt
To learn more about this concept and become a master at LBO modeling, you should check out our LBO Modeling Course.Learn more here.
Module 1: Introduction
Module 2: LBO The Big Picture
Module 3: Valuation and Transaction Assumptions
Module 4: Sources and Uses: The Theory
模块五:来源和用途:应用于耐克Case
Module 6: P&L Projections & LBO Adjustments
Module 7: Debt Schedule
Module 8: Balance Sheet and Adjustments
Module 9: Taxes
Module 10: Exit, Returns, & Sensitivity Analysis
Bonus Module A) Purchase Price Accounting
Bonus Module B) Dividend Recap
Bonus Module C) Add-on Acquisition Build
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