Unformatted text preview: 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
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. Financial leverage results from the presence of fixed financial costs in the firm’s
income stream. Using the framework in Table 11.1, we can define financial
leverage as 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.
The two fixed financial costs that may be found on the firm’s income statement 430 PART 4 Long-Term Financial Decisions are (1) interest on debt and (2) preferred stock dividends. These charges must be
paid regardless of the amount of EBIT available to pay them.6
EXAMPLE Chen Foods, a small Oriental food company, expects EBIT of $10,000 in the current year. It has a $20...
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This document was uploaded on 03/30/2014.
- Spring '14