33.3 Measures of Leverage

Question 1

• Cost structure is …

Answer 1

The mix of a company’s variable costs and fixed costs.

Question 2

Which companies have greater variation in net income (hence more risk)?

Answer 2

Companies that have more fixed costs relative to variable costs in their cost structures..

Question 3

Business risk means?

Answer 3

The risk that the firm’s operating results will fall short of expectations, independently of how the business is financed.

Question 4

Sales risk is … ?

Answer 4

The uncertainty regarding the price and number of units sold of a company’s products.

Question 5

Operating risk is … ?

Answer 5

The risk attributed to the operating cost structure, in particular the use of fixed costs in operations

Question 6

Degree of operating leverage (DOL) - the ratio of … ?

Answer 6

The percentage change in operating income to the percentage change in units sold; the sensitivity of operating income to changes in units sold.

Question 7

• DOL is a quantitative measure of operating risk formula:

Answer 7

DOL = ∆% operating income / ∆% units sold

Question 8

Per unit contribution margin (P – V) is the amount of how … ?

Answer 8

Each unit sold contributes to covering fixed costs—that is, the difference between the price per unit and the variable cost per unit.

Question 9

Contribution margin Q(P-V) - the amount available for … ?

Answer 9

Fixed costs and profit after paying variable costs; revenue minus variable costs.

Question 10

• Degree of operating leverage (DOL) formula:

Answer 10

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.

Question 11

The higher the … leverage factor is, the greater the impact a change in sales volume has on … income.

Answer 11

The higher the operating leverage factor is, the greater the impact a change in sales volume has on operating income.

Question 12

The change in the operating income is calculated as?

Answer 12

∆% operating income = DOL * ∆% units sold

Question 13

· 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.

Answer 13

· 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.

Question 14

Calculating percentage increase in DFL:

- Percentage increase = increase ÷ original number × 100.

Answer 14

DFL = [Q(P−V) − F] / [Q(P−V) − F − C]

Where:
C - fixed financial cost

Question 14

Degree of financial leverage (DFL) - ratio formula?

Answer 14

DFL = ∆% net income / ∆% operating income

Question 14

Net income = … ?

Answer 14

Net income = operating income - interest and taxes

Question 15

· Degree of total leverage DTL is the ratio of?

Answer 15

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.

Question 16

DTL = ?

Answer 16

DTL = ∆%net income / ∆%number of units sold

DTL = Q(P−V) / Q(P−V) − F − C

Question 17

The breakeven point, QBE, is … ?

Answer 17

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.

Question 18

The breakeven point QBE = … ?

Answer 18

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

Question 19

What is important when calculating Degrees of leverage?

Answer 19

To differentiate between F being fixed Operating costs and C being fixed Financial cost.

Question 20

· Operating breakeven point, QOBE is …

Answer 20

The number of units produced and sold at which the company’s operating profit is zero (revenues = operating costs).

Question 21

· Operating breakeven point, QOBE = … ?

Answer 21

QOBE = F / P−V