Leverage Dividends Capital Structure

Leverage Financial leverage reflects the degree to which a company has debt in its capital structure. The more debt is in the capital structure, the higher the leverage of the company. The reason is that with more debt, the company's financial risk is higher. It must pay out more of its earnings to the creditors, increasing the risk that there is nothing left for shareholders. However, of what is left, it is spread among fewer shareholders. As a result, a company that is highly profitable will return tremendously to shareholders.

The returns to shareholders (ROE) are much more volatile the higher the degree of financial leverage a company has. If a firm uses preferred stock in its capital structure, that is still financial leverage. Preferred stock dividends do not typically change, so preferred stock does usually create and maintain an obligation to those shareholders, even if preferred stock is subordinated to debt. Operating leverage reflects the degree of fixed to variable costs in a business.

Fixed costs are the operating equivalent of debt, as they are costs that will be incurred no matter what happens (Investopedia, 2015). So in periods of low demand, the company is at significant risk of losing money, whereas if demand is high, once the fixed costs are covered the company will turn considerable profits.

If a firm uses operating leverage, this creates a situation where the firm needs to focus on driving revenue as much as possible, to cover the fixed costs, because until they are covered the firm will not be profitable, but once they are it can shift to being profitable quite quickly. Combined leverage is the combination of operating and financial leverage. There is sometimes a relationship between these different types of leverage.

One principle with respect to financing is that fixed assets with a specific life span should be financed with debt that matches that life span. Thus, a company with a large amount of fixed assets (high operating leverage) might also have a high amount of financial leverage. An example of this would be an airline, which either buys aircraft with financing, or it has long-term leases on aircraft. In either case, the fixed asset is financed via a debt obligation, providing both a high level of operating and financial leverage.

A software company would be the opposite. A software company has relatively few fixed costs, and may be financed entirely with equity as a result, thus delivering a relatively low amount of both operating and financial leverage. 2. The biggest reason that Apple began paying dividends was shareholder pressure. At the time that Apple made the decision to pay a dividend, it had $137 billion in cash.

Interest rates were (and still are) low, so there was no way for Apple to earn a good return on this money -- anything that Apple was not reinvesting in the business was earning a poor return, thereby lowering the overall return that shareholders earned from the company. Thus, shareholders demanded that Apple put that money to good use and start improving their returns. There were two ways to go about this, and Apple ended up doing both.

First, it could return the money to the shareholders in the form of dividends, and second it could buy back shares, which would prop up the value of those shares by increasing market demand for Apple shares. In both instances, shareholders would reap the rewards. Dividends are a fairly certain way for this to occur, which the market effect of share buybacks is less certain, given that there are other influencers on share price. In any event, it was pressure from the shareholders for Apple.