Operating leverage

Operating leverage - costs will experience MORE variable...

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* Day 10: Part 1 Agenda * Blackboard Grades—All Makeup  work must be completed by August 4  (last day of term) * Book Assignments Due Today by 5:00  PM * Chapter 10: Leverage * Resume Tips * * POW #9 Practice Problem: Emerson  Company  * Break * Business (aka Operating) Risk:       Variability or uncertainty associated  with operating income (i.e. EBIT).  Note:  Specific industry  influences business  risk.
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* Financial Risk:       Risk of distress or  bankruptcy due to the use of fixed cost  financing.  Note:  Management  influences the financial  risk with VC vs. FC decisions. * Sales Volume Variability * Competition * Cost Variability * Product Diversification * Product Demand * Operating Leverage The use of  fixed  operating costs as  opposed to  variable  operating costs. A firm with relatively  HIGH  fixed operating 
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Unformatted text preview: costs will experience MORE variable operating income if sales change. Fixed Costs = Operating Leverage = Business Risk Question: Why do HIGH fixed costs create more variability? With high operating leverage , a small increase in sales produces a relatively larger increase in operating income . Stop to Note: This is the top area of the income statement from sales to EBIT. Operating Leverage : by using fixed operating costs, a small change in sales revenue is magnified into a larger change in operating income . This “multiplier effect” is called the degree of operating leverage (DOL). Example #1: DOL = 2 A 1% increase in sales will result in a 2% increase in operating income (EBIT) ....
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