Homemade leverage
Homemade leverage is an investor's personal borrowing or lending used to replicate or cancel out a firm's own capital structure, so a company's debt-equity mix alone cannot change the return an investor can achieve.
FrameworkModigliani–Miller Proposition I
See it move
Buying 1% of levered Firm L costs €6,000 and returns €1,000 a year. An investor can replicate that by buying 1% of unlevered Firm U for €10,000 instead, funding €6,000 from their own cash and borrowing €4,000 personally at 5%. That position also nets €1,000 a year on the same €6,000 of own money — homemade leverage matches the firm's leverage exactly.
The formula
Variables
- Personal borrowing amount (€)
- Fraction of the levered firm's equity the investor wants to replicate (dimensionless)
- Total debt of the levered firm (€)
Gives the personal borrowing an investor needs to replicate a given ownership stake in a levered firm by instead buying the equivalent stake in an unlevered twin firm.