Finance Lecture 1 Flashcards
Wht is the total cost equation?
Total Cost = Fixed Cost + (Variable Cost X Units Produced)
What does the BEP focus on?
It focusses on the Triangular relationship between: (a) sales volume, (b) Price (c) Cost
What are the Benefits of the BEP?
Benefits of BEP:
- Cost Control
- Obtaining Information regarding the Pricing policy
- Acquiring info on the firms general financial status
- Decisions related to expansion, new product entry etc.
- Analyzing how changes affect production costs, prices etc.
- Decisions regarding the required sales for a new product
- Analyzing Plans regarding modernizing, restructuring endeavors
What are the Drawbacks of BEP?
Drawbacks of BEP:
- Unable to decide sales capacity
- Based on only a single scenario
- There are cost issues if productions increases over capacity
- extra workers may be needed (VC go up)
- overtime may be payed (VC go up)
- New Machinery (FC goes up)
- New Premises (FC goes up)
What is the definition of Operating Leverage?
Operating Leverage refers to the relationship of production volume on profits, when firms have a different FC and VC structure.
What does high operating leverage indicate?
High Operating Leverage -> small changes in sales have big impact on profits
What does low operating leverage indicate?
Low Operating Leverage -> changes in sales have no big impact on profits
Give the definition of the Degree of Operating Leverage (DOL)
DOL is the percentage change in Operating Income to the percentage change in Units sold:
What is the formula for DOL?
What does the DOL for the 3 Firms indicate?
Firm C’s Net Operating Income is more sensitive to changes in sales than the other two
What economics concept does the DOL remind you of?
DOL is a kind of elasticity and thus price elasticity of demand is similar
Looking at the BEPA, at which point is the DOL higher and why?
The DOL is higher closely to the BEP ( where a small change in volume can result in profits) simeply because the profits around the DOL are small, resulting in a higher %Change
How can the above examples be discussed in terms of Financal policy?
With a high DOL, and an agressive sales price policy, it can lead to high profits.
Is a high DOL always desirable?
No because firms that offer seasonal products or are sensitive to general economic conditions may face big variations in their NOI, which in turn might result in losses
Explain the difference between DOL and BEP
BEP emphasises on the volume required to make profits,
DOL shows the sensitivity of profits with respect to changes in volume
What is the Degree of Financial Leverage?
Is concerned with how EBIT affects EPS
Financial Leverage takes over, where operating leverage takes off, hence they are often described as stage I and II of of a leverage analysis.
Financial Leverage arises, like operating leverage due to fixed costs. i.e the financing of the business more specifically.
What is the concept of the Degree of Total Leverage?
