Chapter 10

Chapter 10 - Chapter 10 leverage the magnification of...

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Chapter 10 leverage the magnification of operating or financial results due to the presence of fixed costs. Is a two-edged sword, it magnifies both positive and negative results, making the good times better and the bad times worse. Two types: operating and financial. Operating Leverage the used of fixed operating costs (rent, property tax, administrative salaries) as opposed to variable costs (materials, labor, energy, packing). A firm with relatively high fixed operating costs will experience more varialbe operating income if sales change. Financial Leverage the use of fixed cost sources of financing(debt, preferred stock) rather than variable-cost sources of financing(common stock). Firms that have lots of fixed cost financing (i.e. firms with lots of debt) will have high financial leverage. risk of distress or bankruptcy due to the use of fixed-cost financing. with high financial leverage(high DFL) a small change in operating income is magnified into large change in net income and earnings per share. Two sources of Risk within a company
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Chapter 10 - Chapter 10 leverage the magnification of...

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