Reverse leverage definition
/What is Reverse Leverage?
Reverse leverage occurs when the proceeds from an investment are lower than the cost of funds of a business. In this situation, a business should unwind the investment and pay back the associated funds; otherwise, the firm will continue to experience negative cash flows that could eventually lead to its demise. During periods of spiking interest rates , it is especially critical to review whether reverse leverage is occurring.
Example of Reverse Leverage
David believes that he can generate an excellent return on investment by purchasing a manufacturing company. To do so, he takes on a loan that has a net after-tax cost of 8%. After one year, he finds that the actual net after-tax return on his purchase of the manufacturing company is just 3%. Since he is generating a negative return of 5% on his investment, David has experienced negative leverage.
