With the substitution of the appropriate values into

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Unformatted text preview: ubstitution of the appropriate values into Equation 12.5, the degree of operating leverage at the 1,000-unit base level of sales becomes DOL at 1,000 units 1,000 ($10 $4.50) 1,000 ($10 $4.50) $3,000 $5,500 $2,500 2.2 516 PART 4 Long-Term Financial Decisions TABLE 12.5 Operating Leverage and Increased Fixed Costs Case 2 Case 1 50% 50% Sales (in units) 500 1,000 1,500 Sales revenuea $15,000 $5,000 $10,000 Less: Variable operating costsb 2,250 4,500 6,750 Less: Fixed operating costs 3,000 3,000 3,000 $ 250 $ 2,500 $ 5,250 Earnings before interest and taxes (EBIT) 110% aSales 110% revenue was calculated as indicated in Table 12.4. operating costs $4.50/unit sales in units. bVariable Comparing this value to the DOL of 2.0 before the shift to more fixed costs makes it is clear that the higher the firm’s fixed operating costs relative to variable operating costs, the greater the degree of operating leverage. Financial Leverage financial leverage The potential use of fixed financial costs to magnify the effects of changes in earnings before interest and taxes on the firm’s earnings per share. EXAMPLE Financial leverage results from t...
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