Operating vs Financial Leverage

Operating vs Financial Leverage - Financial Leverage...

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Operating Leverage versus Financial Leverage Operating Leverage In studying business risk, we saw that for a large enough level of expected sales (actual Q > expected Q), EBIT can be increased by taking on greater fixed operating costs (F). This opportunity for higher EBIT from taking on greater fixed operating costs is called “operating leverage.” Doing so, however, exposes the firm to a larger percentage decrease in actual EBIT away from expected EBIT if actual Q falls short of expected Q.
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Unformatted text preview: Financial Leverage Similarly, for a large enough level of actual EBIT > expected EBIT, EPS can be increased by taking on greater interest expense (I) owing to a larger proportion of debt in the firms capital structure. This opportunity for higher EPS from taking on more debt and greater interest expense is called financial leverage. Doing so, however, exposes the firm to a larger percentage decrease in actual EPS away from EPS if actual EBIT falls short of expected EBIT....
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