Leverage

Leverage (effet de levier) refers to the use of debt to amplify investment returns. When a company's return on assets (ROCE) exceeds the after-tax cost of debt, leverage mechanically increases the return on equity — the fundamental principle underlying LBO structures. Conversely, when ROCE falls below the cost of debt, leverage amplifies losses and increases financial distress risk. In WACC construction, a higher leverage ratio reduces the weighted cost of capital (up to the point of financial distress) through the tax shield effect on interest — increasing the theoretical value of equity.

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Example: a fund acquires a company for CHF 40.0 million financing CHF 28.0 million with 5.0% debt and CHF 12.0 million equity. If the company generates a 12% ROCE, equity return reaches approximately 24% — leverage doubles the return. If ROCE falls to 3% (below cost of debt), equity returns become negative — illustrating the symmetrical risk and return amplification of leverage on the equity holders' position.

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Hectelion models leverage effects in LBO and acquisition financing analyses, optimising the risk-return profile for equity investors and lenders.