Operating Leverage and Beta

Operating Leverage and Beta - HAAS SCHOOL OF BUSINESS...

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H AAS S CHOOL OF B USINESS UGBA 103 U NIVERSITY OF C ALIFORNIA AT B ERKELEY A VINASH V ERMA O PERATING L EVERAGE AND THE S YSTEMATIC R ISK Let us denote periodic (typically annual) cash flows that the firm projects as CFs , (periodic) Revenues as R % , (periodic) Fixed Costs as F % , and (periodic) variable costs as V % . Now, in every period in the future cash flows are revenues less fixed and variable costs. Therefore, we can say that: ( 29 ( 29 ( 29 (Assets) ( ) A V PV CFs PV R PV V PV F = = - - % % % % (1) Based on this observation, we can think of the assets, A % , as a portfolio in which a fraction ( 29 / PV R A % % has been invested in the Revenues, a fraction ( 29 / PV V A - % % has been invested in the variable costs, and a fraction ( 29 / PV F A - % % has been invested in the fixed costs. Now, because beta of a portfolio is a sum of the beta of the constituents of the portfolio weighted with the fraction invested in each constituent: 1 1 2 2 ( ) ( ) ( ) ...
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