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