The three basic types of leverage can best be defined

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Unformatted text preview: e 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 Table 12.1. • 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 of Leverage Sales revenue Less: Cost of goods sold Operating leverage Gross profits Less: Operating expenses Earnings before interest and taxes (EBIT) Less: Interest 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 breakeven analysis Indicates the level of operations necessary to cover all...
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This document was uploaded on 01/19/2014.

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