BEC 3: Leverage
What kind of industries have high operating leverage and what kind of industries have low operating leverage?
Capital-Intensive industries have high operating leverage and labor-intensive industries have low operating leverage
What is Financial Leverage?
It is the degree to which a company uses debt rather than equity to finance the company.
What is operating leverage?
It is the degree to which a company uses fixed operating costs rather than variable operating costs
What is the implication of a company with high financial leverage?
It must produce enough operating income to cover its fixed interest costs. But the higher degree of financial leverage implies that a small change in earnings before interest and taxes will have a greater effect on profits.
What is the implication of a company with high operating leverage?
It must produce enough sales revenue to cover its high fixed operating costs. It will have greater risk but greater possible returns.
What are the 2 types of leverage?
Operating Leverage and Financial Leverage
What is the Degree of Operating Leverage formula?
% Change in Earnings before Income Taxes divided by % change in sales
What is the Degree of Financial Leverage formula?
% Change in Earnings per share divided by % Change in EBIT