33.3 Measures of Leverage Flashcards
- Cost structure is …
The mix of a company’s variable costs and fixed costs.
Which companies have greater variation in net income (hence more risk)?
Companies that have more fixed costs relative to variable costs in their cost structures..
Business risk means?
The risk that the firm’s operating results will fall short of expectations, independently of how the business is financed.
Sales risk is … ?
The uncertainty regarding the price and number of units sold of a company’s products.
Operating risk is … ?
The risk attributed to the operating cost structure, in particular the use of fixed costs in operations
Degree of operating leverage (DOL) - the ratio of … ?
The percentage change in operating income to the percentage change in units sold; the sensitivity of operating income to changes in units sold.
- DOL is a quantitative measure of operating risk formula:
DOL = ∆% operating income / ∆% units sold
Per unit contribution margin (P – V) is the amount of how … ?
Each unit sold contributes to covering fixed costs—that is, the difference between the price per unit and the variable cost per unit.
Contribution margin Q(P-V) - the amount available for … ?
Fixed costs and profit after paying variable costs; revenue minus variable costs.
- Degree of operating leverage (DOL) formula:
DOL = Q(P−V) / Q(P−V) − F
Where:
- Q is the number of units,
- P is the price per unit,
- V is the variable operating cost per unit,
- F is the fixed operating cost.
The higher the … leverage factor is, the greater the impact a change in sales volume has on … income.
The higher the operating leverage factor is, the greater the impact a change in sales volume has on operating income.
The change in the operating income is calculated as?
∆% operating income = DOL * ∆% units sold
· Degree of financial leverage (DFL) - the ratio of the percentage change in net income to the percentage change in operating income; the sensitivity of the cash flows available to owners when operating income changes.
· Degree of financial leverage (DFL) - the ratio of the percentage change in net income to the percentage change in operating income; the sensitivity of the cash flows available to owners when operating income changes.
Calculating percentage increase in DFL:
- Percentage increase = increase ÷ original number × 100.
DFL = [Q(P−V) − F] / [Q(P−V) − F − C]
Where:
C - fixed financial cost
Degree of financial leverage (DFL) - ratio formula?
DFL = ∆% net income / ∆% operating income
Net income = … ?
Net income = operating income - interest and taxes
· Degree of total leverage DTL is the ratio of?
The percentage change in net income to the percentage change in units sold; the sensitivity of the cash flows to owners to changes in the number of units produced and sold.
DTL = ?
DTL = ∆%net income / ∆%number of units sold
DTL = Q(P−V) / Q(P−V) − F − C
The breakeven point, QBE, is … ?
The number of units produced and sold at which the company’s net income is zero—the point at which revenues are equal to costs.
The breakeven point QBE = … ?
QBE = F+C / P−V
Where:
- P = the price per unit
- Q = the number of units produced and sold
- V = the variable cost per unit
- F = the fixed operating costs
- C = the fixed financial cost
What is important when calculating Degrees of leverage?
To differentiate between F being fixed Operating costs and C being fixed Financial cost.
· Operating breakeven point, QOBE is …
The number of units produced and sold at which the company’s operating profit is zero (revenues = operating costs).
· Operating breakeven point, QOBE = … ?
QOBE = F / P−V
