Impact of Financial Leverage on Cost of Capital and Valuation of Firm: A Study of Indian Cement Industry (Report‪)‬

Introduction In running business activities smoothly every industrial organization must have adequate amount of capital at its disposal. As capital is regarded as the lifeblood of an organization and are available in a limited quantity, an industrial organization must acquire and is spend the same in a planned and systematic manner. In general, the potential sources of capital are owner's equity, retained earning, undistributed profit, and borrowed money. For most large business operations, borrowed money from banks and other specialized financial institutions is used. The policy of supplementing owner's equity with borrowed money can only be supported when the return on investment (ROI) is sufficiently large and a bigger margin of income is available after meeting all fixed charges including cost of capital. It has been observed that a large number of industrial organizations have a propensity of making a lavish use of borrowed money without considering its earning potential; such a policy can spell disaster for the enterprise leading to failure and bankruptcy in the long run. Another policy often adopted by industrial undertakings is the unplanned and indiscriminate use of borrowed money and other modes of financing which totally distorts its capital structure. The ultimate implications of such policies on the financial position of an industrial organization can be very both in the short-term and long-term perspective.