11-Capital-structure - Capital Structure Business risk...

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Capital Structure 1 Capital Structure Business risk Operating leverage and risk Financial leverage and risk Capital structure theory Finding the optimal capital structure
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Capital Structure 2 Uncertainty about future operating income (EBIT), i.e., how well can we predict operating income? Note that business risk does not include financing effects. What is business risk? Probability EBIT E(EBIT) 0 Low risk High risk
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Capital Structure 3 Factors That Influence Business Risk Product, and other types of liability . Uncertainty about demand for product (number of units sold) . Uncertainty about output prices. Uncertainty about input costs . Degree of operating leverage (DOL) .
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Capital Structure 4 What is operating leverage, and how does it affect a firm’s business risk? Operating leverage is the use of fixed operating costs rather than variable costs, in product’s total cost. If most operating costs are fixed, hence do not decline when demand falls, then the firm has high operating leverage .
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Capital Structure 5 More operating leverage leads to more business risk. A small sales decline causes a big profit decline. Sales $ Revenue TC FC Q BE Sales $ Revenue TC FC Q BE Profit
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6 Probability EBIT L Low operating leverage High operating leverage
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This note was uploaded on 10/04/2011 for the course FIN 6406 taught by Professor Sturm,r during the Spring '08 term at University of Central Florida.

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11-Capital-structure - Capital Structure Business risk...

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