CFA 37: Measures of Leverage

Question 1

cost structure

Answer 1

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

Question 2

variable cost

Answer 2

costs that fluctuate with the level of products and sales

Question 3

fixed cost

Answer 3

costs that remain at the same level regardless of a company’s level of production and sales

Question 4

business risk

Answer 4

risk associated with operating earnings

Question 5

sales risk

Answer 5

uncertainty with respect to price and quantity

Question 6

operating risk

Answer 6

risk attributed to the operating cost structure, in particular the use of fixed costs in operations; the risk arising from the mix of fixed and variable costs - the greater the fixed operating costs relative to variable operating costs, the greater the operating risk

Question 7

elasticity

Answer 7

a measure of the sensitivity of changes in one item to changes in another

Question 8

Degree of Operating Leverage (DOL)

Answer 8

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

Question 9

per unit contribution margin

Answer 9

The amount that each unit sold contributes to covering fixed costs - that is, the difference between the price per unit and the variable cost per unit.

Question 10

contribution margin

Answer 10

The amount available for fixed costs and profit after paying variable costs; revenue minus variable costs.

Question 11

financial risk

Answer 11

The risk that environmental, social, or governance risk factors will result in significant costs or other losses to a company and its shareholders; the risk arising from a company’s obligation to meet required payments under financing agreements.

Question 12

Degree of Financial Leverage (DFL)

Answer 12

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 13

Degree of Total Leverage (DTL)

Answer 13

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.

Question 14

breakeven point

Answer 14

number of units at which the net income is zero; number of units at which the company goes from being unprofitable to to being profitable

Question 15

operating breakeven

Answer 15

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

Question 16

reorganization

Answer 16

Agreements made by a company in bankruptcy under which a company’s capital structure is altered and/or alternative arrangements are made for debt repayment; US Chapter 11 bankruptcy. The company emerges from bankruptcy as a going concern.

Question 17

liquidation

Answer 17

To sell the assets of a company, division, or subsidiary piecemeal, typically because of bankruptcy; the form of bankruptcy that allows for the orderly satisfaction of creditors’ claims after which the company ceases to exist.