Measures of leverage Flashcards
What is the leverage?
It refers to a company’s use of fixed costs in conducting business.
By what is leverage affected?
It is affected by a company’s cost structure, such as variable costs and fixed costs.
What happens to the slope of the line representing net income when the degree of leverage increases?
The slope line representing net income is steeper.
What is the business risk?
It is the risk associated with a company’s operating earnings. It is broken down into sales risk and operating risk.
What is sales risk?
It is the uncertainty associated with total revenue since revenue is affected by economic conditions, industry dynamics, government regulation, and demographics.
What is the operating risk?
It is the risk associated with a company’s operating cost structure.
What do we use to examine a company’s sensitivity of operating income to changes in unit sales?
We use the degree of operating leverage (DOL)
What is the financial risk?
It is the risk associated with how a company chooses to finance its operations.
What financial choice increases the most financial risk?
The higher the amount of fixed financial cost (debt-like), the greater the risk.
How can financial risk be measured?
It can be measured as the sensitivity of CF available to owners to changes in operating income. This is known as the degree of financial leverage (DFL).
What is the degree of total leverage (DTL)?
It looks at the combined effect of operating and financial leverage. It measures the sensitivity of NI to changes in units produced and sold.
What is the operating breaking point?
At this point, revenues are equal to operating profits.
What does the reorganization (chapter 11) is?
It provides the company temporary protection from creditors to reorganize its capital structure and emerge from bankruptcy as a going concern.
What does liquidation (chapter 7) is?
It allows for an orderly settlement of the creditors’ claims. In this category of bankruptcy, the original business ceases to exist.
What are companies with high financial leverage most likely to use?
Chapter 11 to change their capital structure and emerge as ongoing concerns once the restructuring is complete.
What is the formula for the DOL?
What is the formula for the DFL?
What is the formula for the DTL?
