Solutions to Web Appendix 14A

Solutions to Web Appendix 14A - DegreeofLeverage...

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Web Appendix 14A Degree of Leverage Answers to Questions 14A-1 An increase in a firm’s operating leverage would call for the firm to use less debt in its optimal  capital structure.  A decrease in the firm’s operating leverage would call for the firm to use more  debt in its optimal capital structure.   Operating leverage is the firm’s use of fixed costs in its  operations.  One can think of interest on debt as a fixed financial cost so if operating fixed costs are  set high, interest or fixed financial costs must be low. 14A-2 Short-term leases are not capitalized.   By replacing fixed assets with short-term leases (which  would be off the balance sheet) the firm would be increasing its operating leverage (leasing  expense would be operating costs), lowering its financial leverage (because leases would be off the  balance sheet), but the net effect of total leverage would be the same—no change. 14A-3 DTL = DOL  ×  DFL. The greater the use of fixed operating costs as measured by the degree of operating leverage,  the more sensitive EBIT will be to changes in sales. The greater the use of debt as measured by the degree of financial leverage, the more 
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This note was uploaded on 03/21/2010 for the course BUSINESS AB102 taught by Professor Woo during the Spring '10 term at Nanzan.

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Solutions to Web Appendix 14A - DegreeofLeverage...

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