Study Unit 1.4: Leverage Flashcards
Operating Leverage
arises from the use of a high level of plant and machinery in the production process, revealed through charges for depreciation, property taxes,etc.
Finance Leverage
arises from the use of high level of debt in the firm’s financing structure, revealed through amounts paid out of interest
Degree of Operating Leverage (DOL single period)
Contribution Margin / Operating income or EBIT
*Requires financial information based on variable costing as it isolates the use of fixed costs
Degree of Operating Leverage (DOL multiple period)
% change in operating or EBIT / % change in Sales
Degree of Financial Leverage (DOF single period)
EBIT / EBT
Isolates the effects of interest as the only true fixed financing cost
Degree of Financial Leverage (DOF multiple period)
% change in net income / % change in EBIT
Identify five factors that influence a company’s capital structure
- Companies with relatively stable sales vs. companies with highly cyclical industries
- First with assets that are suitable as security for loans
- Levels of operating risk
- Growth rates
- Effective tax rate
- Amount of debt vs. amount of equity
- Rating agency assessments
- Market conditions
- Financial flexibility