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

Abstract

In corporate finance, financing decision has gained greater importance because the optimal capital structure can be created through proper mix of finance. Corporate managers generally prefer borrowings over other means of financing. Management of a company has to be very careful while deciding the extent of financial leverage in its capital structure because the right use of financial leverage can increase the shareholders' wealth whereas its improper use would adversely affect the interest of shareholders. This study examines the empirical effects of corporate capital structure (financial leverage) on cost of capital and the market value of selected firms of Indian Cement Industry for the period from 2000-01 to 2007-08. The research evidence of the study indicates that no impact of financial leverage on cost of capital was found in the cement industry in India, i.e. no significant linear relationship between the financial leverage and cost of capital exists, and there is no correlation between the financial leverage and total valuation within the cement industry. Or in other words, financial leverage does not affect the total valuation of a firm in the cement industry in India.