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E X A M P L ESubstituting the values calculated for DOL and DFL, shown on the right-handside of Table 12.7, into Equation 12.10 yieldsDTL1.25.06.0The resulting degree of total leverage is the same value that we calculated directlyin the preceding examples. R e v i e w Q u e s t i o n s12–1What is meant by the term leverage?How are operating leverage, financialleverage, and total leverage related to the income statement?12–2What is the operating breakeven point?How do changes in fixed operat-ing costs, the sale price per unit, and the variable operating cost per unitaffect it?12–3What is operating leverage?What causes it? How is the degree of operat-ing leverage (DOL)measured?12–4What is financial leverage?What causes it? How is the degree of financialleverage (DFL)measured?12–5What is the general relationship among operating leverage, financial lever-age, and the total leverage of the firm? Do these types of leverage comple-ment each other? Why or why not?
522PART 4Long-Term Financial DecisionsThe various types and characteristics of corporate bonds,a major source ofdebt capital,were discussed in detail in Chapter 6. The cost of debt is lower thanthe cost of other forms of financing. Lenders demand relatively lower returnsbecause they take the least risk of any long-term contributors of capital: (1) Theyhave a higher priority of claim against any earnings or assets available for pay-ment. (2) They can exert far greater legal pressure against the company to makepayment than can holders of preferred or common stock. (3) The tax deductibil-ity of interest payments lowers the debt cost to the firm substantially.Unlike debt capital, which must be repaid at some future date,equity capitalis expected to remain in the firm for an indefinite period of time. The two basic