How to Calculate Leveraged Return in Excel
Understanding the impact of debt on your investment returns is a crucial aspect of financial analysis, and the concept of leveraged return helps quantify this impact. Leveraged return essentially measures the percentage change in an investor’s return that results from using debt to finance an investment.
To calculate leveraged return, you first need to understand the core components involved in the calculation. These typically include the initial investment amount, the amount of debt used to finance the investment, the return on the total investment, and the cost of the debt (interest rate). The fundamental idea is to see how the return on the assets acquired through borrowing compares to the cost of borrowing.
Let’s consider a scenario to illustrate this. Imagine you want to invest in an asset that costs $100,000. You decide to finance $60,000 of this investment with debt that carries an annual interest rate of 5%. Your initial equity investment is therefore $40,000 ($100,000 – $60,000). After one year, the total value of the asset has increased to $115,000, representing a 15% return on the total investment ($15,000 gain / $100,000 initial investment).
Now, let’s calculate the leveraged return in Excel. You will need to organize your data in separate cells. For instance, you could have the initial investment amount in cell A1 (e.g., 100000), the amount of debt in cell A2 (e.g., 60000), the interest rate on the debt in cell A3 (e.g., 0.05), and the total return on investment in cell A4 (e.g., 0.15).
The first step in calculating the leveraged return is to determine the return generated by the total investment. In our example, this is already given as 15%. Next, you need to calculate the cost of the debt. This is done by multiplying the amount of debt by the interest rate. In Excel, this would be represented by the formula =A2*A3. This calculation will give you the total interest paid on the debt for the year. In our example, this would be $60,000 * 0.05 = $3,000.
The net return attributable to your equity investment is the total return from the investment minus the cost of the debt. The total dollar return from the investment is the initial investment multiplied by the total return on investment, which in Excel would be =A1*A4. In our example, this is $100,000 * 0.15 = $15,000. Subtracting the interest cost from this gives us the net return: $15,000 – $3,000 = $12,000.
Finally, to calculate the leveraged return, you divide the net return attributable to your equity by your initial equity investment. Your initial equity investment is the initial investment amount minus the amount of debt, which in Excel would be =A1-A2. In our example, this is $100,000 – $60,000 = $40,000. Therefore, the leveraged return is the net return ($12,000) divided by the initial equity ($40,000), which in Excel would be =(A1*A4 – (A2*A3))/(A1-A2). This formula combines all the steps to directly calculate the leveraged return. In our example, this would result in a leveraged return of 0.30 or 30%.
This result of 30% is higher than the 15% return on the total investment, illustrating the positive impact of leverage in this scenario. By using debt at a cost lower than the return generated by the assets acquired, the return on the investor’s own capital is amplified.
It’s important to note that leverage can also amplify losses. If the return on the total investment were lower than the cost of debt, the leveraged return would be negative, indicating that the use of debt worsened the investor’s returns.
