Financial Leverage

Define DOL

Degree of Operating Leverage (sales - variable costs) / EBIT

What does EBIT mean?

Earnings before interest and taxes

Firms with high fixed cost of financing have lots of

Financial leverage

What is financial leverage used for?

Fixed financing costs

What is operating leverage used for?

Fixed operating costs

What are the two types of leverage?

Operating and financial

Financial risk

Risk distress or bankruptcy due to the use of fixed cost financing Largely a result of the managers decisions

Business risk is associated with

Sales volume variability Competition Cost Variability Product diversification Product demand Operating leverage

Define contribution margin

The revenue after variable costs that can be applied to the fixed costs and move toward break even.

Break-even formula

Total FC / Unit Contribution Margin

What is business risk?

Variability associated with operating income Largely a function of the industry in which the company operates