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leverage, particularly when making capital structure decisions.
The three basic types of leverage can best be defined with reference to the
firm’s income statement, as shown in the general income statement format in
• Operating leverage is concerned with the relationship between the firm’s
sales revenue and its earnings before interest and taxes, or EBIT. (EBIT is a
descriptive label for operating profits.)
• Financial leverage is concerned with the relationship between the firm’s EBIT
and its common stock earnings per share (EPS).
• Total leverage is concerned with the relationship between the firm’s sales revenue and EPS.
We will examine the three types of leverage concepts in detail in sections that
follow. First, though, we will look at breakeven analysis, which lays the foundation for leverage concepts by demonstrating the effects of fixed costs on the firm’s
operations. TABLE 12.1 General Income Statement Format and Types
Less: Cost of goods sold Operating leverage Gross profits
Less: Operating expenses
Earnings before interest and taxes (EBIT)
Net profits before taxes
Less: Taxes Financial leverage Net profits after taxes
Less: Preferred stock dividends
Earnings available for common stockholders
Earnings per share (EPS) Total leverage CHAPTER 12 Leverage and Capital Structure 509 Breakeven Analysis
Indicates the level of operations
necessary to cover all...
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