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17 Cards in this Set
- Front
- Back
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Define Leverage in terms of Finance
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Leverage is used to describe the impact of Fixed Costs on the operating and financial results of the firm
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What are some examples of Fixed Operating Costs?
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-rent
-property tax -administrative salaries |
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What are some examples of Variable Operating Costs?
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-Materials
-Labor -Energy -Packaging |
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True of False- Firms with HIGH fixed costs have HIGH operating leverage
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TRUE
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Financial Leverage refers to what?
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The amount of fixed cost sources of Financing such as: Debt and Preferred Stock
*** With HIGH financial Leverage, a small change in operating income is magnified into a large change in net income |
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What are the Two Sources of Risk?
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1) Business (or Operating) Risk-- Variability associated with Operating Income
2) Financial Risk -- risk of distress or bankruptcy due to the use of fixed cost financing |
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Business Risk can be affected by what factors?
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1) Sales Volume Variability
2) Competition 3) Cost Variability 4) Product Diversification 5) Product Demand 6) Operating Leverage |
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True or False- INCREASING Operating Leverage INCREASES Business Risk
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TRUE
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Define Operating Leverage
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The use of FIXED operating costs as opposed to VARIABLE operating costs
*** With HIGH Operating Leverage, a small change in sales produces a relatively large change in Operating Income |
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Define Breakeven Point
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Total Fixed Cost / (Price - Variable Cost)
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What is the affect of decreasing Variable Costs and adding more fixed costs?
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Getting rid of Variable Costs make it so that when sales are high your Net Income increases by a lot, but when sales are low then your losses are magnified
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What is DOL?
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Degree of Operating Leverage.
DOL = (% change in EBIT) / (% change in Sales) or DOL = (Sales - Variable Costs) / EBIT |
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Since Financial Leverage is the use of Debt for financing, what is an example of Financial Leverage?
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Real Estate, Bank Loans
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What is DFL?
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Degree of Financial Leverage
DFL = (% change in Net Income) / (% change in EBIT) or DFL = EBIT / (EBIT - Interest Expense) |
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What pertains to (Sales to EBIT) and what pertains to (EBIT to Net Income)
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DOL = Sales to EBIT
DFL = EBIT to Net Income |
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What is DCL?
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Degree of Combined Leverage
DCL = (Sales - VC) / (EBIT - Interest) or DCL = DOL * DFL |
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What did we learn about M&Ms for "Optimal Capital Structure"?
(Not sure if important) |
1) In a "Frictionless" world the value of an unlevered firm equals exactly the value of a levered firm
2) The rate of return on equity increases as the firm's debt to equity increases 3) Essentially in an M&M world with taxes, the tax shield created by debt increases the size of the pie! Using 100% debt would create the biggest pie possible |
