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Homework answers / question archive / Please keep your answers coherent and brief
Please keep your answers coherent and brief. a. Private equity (PE) engages in investment by taking a company into private ownership in order to restructure it and selling it in the future at a hoped-for profit. A common feature of PE operation is to use leverage when investing a company. Please explain the meaning of using leverage in PE operation and briefly explain why PEs prefer to use leverage instead of funding the investment fully by themselves.
Leverage is the inclusion of debt in the capital structure to increase the potential return of an investment. Now PE's use this extensively because the post tax cost of debt is lower than equity and that way the PE's can arrange for a finance easily. Also the PE will hypothecate the asets of the target company and the cash flows form the same cab be used to service the debt, This will increase the risk however it will also increase te potential earnings. in a nutshell if the investment pays off the PE will make huge returns as compared to its investment.
