Ch 2, Module 2

Question 1

Define operating leverage

Answer 1

the degree to which a company uses fixed operating costs rather than variable operating costs (i.e. rent, depreciation, and insurance expense)

Capital intensive industries often have high operating leverage

Labor intensive industries generally have low operating leverage

Question 2

Define financial leverage

Answer 2

degree to which a company uses debt rather than equity to finance the company (because, when debt is issued, the firm is generally required to pay a fixed interest cost)

Question 3

What is a “levered firm”

Answer 3

a company that has debt in its capital structure

an unlevered firm has only equity in its structure