Chapter 12_Leverage_Text and end of chapter questions_2 - Chapter 12 Leverage and Capital Structure Principles of Managerial Finance An-Najah National

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Chapter 12 Leverage and Capital Structure Principles of Managerial Finance An-Najah National University Prepared by Lecturer: E.Shatha Qamhieh
Part one : Leverage Leverage Refers to the effects that fixed costs have on the returns that shareholders earn; higher leverage generally results in higher but more volatile returns. Types of leverage include: 1.Operating Leverage 2.Financial Leverage 3.Total Leverage 4/16/2012 2 Managerial Finance_An-Najah University
Relationship between Operating Leverage Sales revenue Operating Profit EBIT Financial Leverage Operating Types of leverage Relationship between Profit EBIT EPS Relationship between Total Leverage Sales Revenue EPS 4/16/2012 3 Managerial Finance_An-Najah University
General Multistep Income Statement Format and Types of Leverage 4/16/2012 4 Managerial Finance_An-Najah University
4/16/2012 5 Managerial Finance_An-Najah University
Using Contribution Margin Concept to determine Operating Breakeven Point P = sales price per unit Sales Revenue (P × Q) Operating Leverage Less : Variable Operating Expenses - (VC × Q) Less: Fixed Operating Expenses - FC__ Earning before Interest and Taxes EBIT Q = sales quantity in units FC = fixed operating costs per period VC = variable operating costs per unit EBIT = operating profit EBIT = (P x Q) - (VC x Q) - FC Rewriting the algebraic calculations 4/16/2012 6 Managerial Finance_An-Najah University
FC FC = 7 Managerial Finance_An-Najah University
How changes in FC, P , FC will change Q O.B.E ______Variable_______ Change Effect on Q O.B.E. FC (P - VC) Q O.B.E = Fixed operating cost (FC) Increase Increase Decrease Decrease Selling price per unit (P) Increase Decrease Decrease Increase Variable operating cost (VC) Increase Increase Decrease Decrease 4/16/2012 8 Managerial Finance_An-Najah University
Conclusions of Operating Breakeven Point Q Sales > Q O.B.E Q Sales = Q O.B.E EBIT > 0 If Then Q Sales < Q O.B.E EBIT = 0 EBIT < 0 Breakeven analysis can be called Cost-Volume-Profit analysis 4/16/2012 9 Managerial Finance_An-Najah University
operating leverage The use of fixed operating costs to magnify the effects of