analysis and impact of leverage
DESCRIPTION
Analysis and Impact of Leverage. Chapter 15. Goal of a firm. - PowerPoint PPT PresentationTRANSCRIPT
![Page 1: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/1.jpg)
1
Analysis and Impact Analysis and Impact of Leverageof Leverage
Chapter 15Chapter 15
![Page 2: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/2.jpg)
3Goal of a firmGoal of a firm
Managers' objective is to maximize stockholders' wealth--maximize the price of the firm's stock. We noted in an earlier chapter that the capital structure that produces the lowest WACC (risk) is also the one that maximizes share price.
![Page 3: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/3.jpg)
4RiskRisk
Variability of the expected net income (EPS)Variability of the expected net income (EPS)
![Page 4: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/4.jpg)
5RiskRisk
Variability of revenues from expectedVariability of revenues from expectedTwo types of Risk: Business Risk & Financial RiskTwo types of Risk: Business Risk & Financial Risk
![Page 5: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/5.jpg)
6RiskRisk
Variability of revenues from expectedVariability of revenues from expectedTwo types of Risk: Business Risk & Financial RiskTwo types of Risk: Business Risk & Financial Risk
RevenueRevenue-Variable Cost -Variable Cost Contribution marginContribution margin-Fixed cost-Fixed cost=EBIT/operating profits=EBIT/operating profits--InterestInterest=NI=NI
![Page 6: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/6.jpg)
7RiskRisk
Variability of revenues from expectedVariability of revenues from expectedTwo types of Risk: Business Risk & Financial RiskTwo types of Risk: Business Risk & Financial Risk
Business RiskBusiness RiskRisk Due to Operations
![Page 7: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/7.jpg)
8RiskRisk
Variability of revenues from expectedVariability of revenues from expectedTwo types of Risk: Business Risk & Financial RiskTwo types of Risk: Business Risk & Financial Risk
Business RiskBusiness RiskRisk Due to Operations
Measured by variability of EBIT (earnings before interest and taxes)
![Page 8: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/8.jpg)
9RiskRisk
Variability of revenues from expectedVariability of revenues from expectedTwo types of Risk: Business Risk & Financial RiskTwo types of Risk: Business Risk & Financial Risk
Business RiskBusiness RiskRisk Due to OperationsMeasured by variability of EBIT (earnings before
interest and taxes)Coefficient of Variation of EBIT
=Standard Deviation of EBIT
Expected EBIT
![Page 9: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/9.jpg)
10RiskRisk
Variability of revenues from expectedVariability of revenues from expectedTwo types of Risk: Business Risk & Financial RiskTwo types of Risk: Business Risk & Financial Risk
Financial RiskFinancial RiskRisk due to raising money with fixed income securities
![Page 10: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/10.jpg)
11Business RiskBusiness Risk
Major determinants of business risk
1. Demand Variability2. Sales Price Variability3. Input Price variability.4. Inability to adjust output prices for a change in input prices-a utility can
transfer costs more easily5. Operating Leverage--the extent to which costs are 'fixed' (the ratio of
fixed cost to total cost).
Business risk not only varies from industry to industry, it varies among firms in a given industry.
Business risk of a firm can change over time.
![Page 11: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/11.jpg)
12RiskRisk
Financial RiskFinancial RiskRisk due to raising money with fixed income securitiesFinancial risk is high with high levels of debt financing
![Page 12: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/12.jpg)
13RiskRisk
Financial RiskFinancial RiskRisk due to raising money with fixed income securitiesFinancial risk is high with high levels of debt financingFinancial leverage - the use of fixed income securities
to finance a portion of assets
![Page 13: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/13.jpg)
14RiskRisk
Financial RiskFinancial RiskRisk due to raising money with fixed income securitiesFinancial risk is high with high levels of debt financingFinancial leverage - the use of fixed income securities
to finance a portion of assetsExample
Firm A is an all equity firm -- it has no financial leverage
![Page 14: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/14.jpg)
15RiskRisk
Financial RiskFinancial RiskRisk due to raising money with fixed income securitiesFinancial risk is high with high levels of debt financingFinancial leverage - the use of fixed income securities
to finance a portion of assetsExample
Firm A is an all equity firm -- it has no financial leverageFirm B is financed by 50% debt and 50% equity -- it uses
financial leverage
![Page 15: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/15.jpg)
16RiskRisk
Notes:
1. Business risk is largely determined by technology and by industry/market conditions, although management decisions, to some extent, do matter.
2. Financial risk is largely management determined.
3. If business risk is high, financial risk (leverage) should be restrained.
![Page 16: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/16.jpg)
17Break-even AnalysisBreak-even Analysis
The point of sales where operating profits are zero. The point of sales where operating profits are zero. The point where revenues barely cover all costs.The point where revenues barely cover all costs.
Steps to SolutionSteps to SolutionDetermine the quantity of output which results in an
EBIT = $0
![Page 17: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/17.jpg)
18Break-even AnalysisBreak-even Analysis
Steps to SolutionSteps to SolutionDetermine the quantity of output which results in an
EBIT = $0Shows output necessary to cover operating (not
financial) costs
![Page 18: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/18.jpg)
19Break-even AnalysisBreak-even Analysis
Steps to SolutionSteps to SolutionDetermine the quantity of output which results in an
EBIT = $0Shows output necessary to cover operating (not
financial) costsCalculate EBIT at various output levels
![Page 19: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/19.jpg)
20Break-even AnalysisBreak-even Analysis
Steps to SolutionSteps to SolutionDetermine the quantity of output which results in an
EBIT = $0Shows output necessary to cover operating (not
financial) costsCalculate EBIT at various output levelsApplications
Capital Expenditure Analysis
![Page 20: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/20.jpg)
21Break-even AnalysisBreak-even Analysis
Steps to SolutionSteps to SolutionDetermine the quantity of output which results in an
EBIT = $0Shows output necessary to cover operating (not
financial) costsCalculate EBIT at various output levelsApplications
Capital Expenditure AnalysisDetermining PricesEvaluating Fixed vs. Variable Costs
![Page 21: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/21.jpg)
22Break-even AnalysisBreak-even Analysis
AssumptionsAssumptionsFixed costs remain constant as quantity changes
Fixed Costs Includes:Salaries, Depreciation, Rent
Fixed Costs Includes:Salaries, Depreciation, Rent
![Page 22: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/22.jpg)
23Break-even AnalysisBreak-even Analysis
AssumptionsAssumptionsFixed costs remain constant as quantity changes
Fixed Costs Includes:Salaries, Depreciation, Rent
Fixed Costs Includes:Salaries, Depreciation, Rent
Variable Costs Includes:Materials, Labor, Commissions
Variable Costs Includes:Materials, Labor, Commissions
Variable costs vary as quantity of output changes: they are constant per unit of output
Drop Semivariable costs
![Page 23: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/23.jpg)
24Break-even AnalysisBreak-even Analysis
AssumptionsAssumptionsFixed costs remain constant as quantity changes
Variable costs vary as quantity of output changes: they are constant per unit of output
Quantity Sold
Costs$
Fixed Costs
Variable Costs
![Page 24: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/24.jpg)
25Break-even AnalysisBreak-even Analysis
AssumptionsAssumptionsFixed costs remain constant as quantity changes
Fixed Costs Includes:Salaries, Depreciation, Rent
Fixed Costs Includes:Salaries, Depreciation, Rent
Variable Costs Includes:Materials, Labor, Commissions
Variable Costs Includes:Materials, Labor, Commissions
Variable costs vary as quantity of output changes: they are constant per unit of output
Revenues are quantity sold times price per unit
![Page 25: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/25.jpg)
26Break-even AnalysisBreak-even Analysis
Calculation of Break-even QuantityCalculation of Break-even Quantity
EBIT = Sales – Variable Costs - Fixed Costs
Find Quantity which results in EBIT = $0Find Quantity which results in EBIT = $0
![Page 26: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/26.jpg)
27Break-even AnalysisBreak-even Analysis
Calculation of Break-even QuantityCalculation of Break-even QuantityTrial and Error Method
Choose arbitrary output levelCalculate EBITIf EBIT < 0, choose a larger output levelIf EBIT > 0, choose a lower output levelContinue until find a level of output which results in EBIT
= $0
![Page 27: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/27.jpg)
28Break-even AnalysisBreak-even Analysis
Calculation of Break-even QuantityCalculation of Break-even Quantity
QB =
Algebraic AnalysisAlgebraic Analysis
F P – V
Where:QB = Break-even QuantityP = Price per UnitF = Total Fixed CostsV = Variable Costs per Unit
![Page 28: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/28.jpg)
29Break-even AnalysisBreak-even Analysis
Calculation of Break-even QuantityCalculation of Break-even Quantity
QB =
Example:Example:
F P – V
Fixed Costs = $1,000,000 per yearPrice = $800/unitVariable Costs = $400/unit
![Page 29: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/29.jpg)
30Break-even AnalysisBreak-even Analysis
Calculation of Break-even QuantityCalculation of Break-even Quantity
QB =
Example:Example:
F P – V
Fixed Costs = $1,000,000 per yearPrice = $800/unitVariable Costs = $400/unit
QB = $1,000,000 $800 – $400
![Page 30: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/30.jpg)
31Break-even AnalysisBreak-even Analysis
Calculation of Break-even QuantityCalculation of Break-even Quantity
QB =
Example:Example:
F P – V
Fixed Costs = $1,000,000 per yearPrice = $800/unitVariable Costs = $400/unit
QB = $1,000,000 $800 – $400
= 2,500 Units
![Page 31: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/31.jpg)
32Break-even AnalysisBreak-even Analysis
Calculation of Break-even Sales Level (S*)Calculation of Break-even Sales Level (S*)
S* = QB x P
To Find S* for a single product use Break-even Quantity (QTo Find S* for a single product use Break-even Quantity (QBB):):
![Page 32: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/32.jpg)
33Break-even AnalysisBreak-even Analysis
Calculation of Break-even Sales Level (S*)Calculation of Break-even Sales Level (S*)
S* = QB x P
S* = 2,500 units x $800
To Find S* for a single product use Break-even Quantity (QTo Find S* for a single product use Break-even Quantity (QBB):):
![Page 33: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/33.jpg)
34Break-even AnalysisBreak-even Analysis
Calculation of Break-even Sales Level (S*)Calculation of Break-even Sales Level (S*)
S* = QB x P
To Find S* for a single product use Break-even Quantity (QTo Find S* for a single product use Break-even Quantity (QBB):):
S* = 2,500 units x $800
= $2,000,000
![Page 34: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/34.jpg)
35Break-even AnalysisBreak-even Analysis
Calculation of Break-even Sales Level (S*)Calculation of Break-even Sales Level (S*)May want to Calculate the Break-even Sales Level (S*)
for the entire firm with many products
![Page 35: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/35.jpg)
36Break-even AnalysisBreak-even Analysis
Calculation of Break-even Sales Level (S*)Calculation of Break-even Sales Level (S*)May want to Calculate the Break-even Sales Level (S*)
for the entire firm with many productsCalculate from Income Statement data at a particular
Sales Level
![Page 36: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/36.jpg)
37Break-even AnalysisBreak-even Analysis
Calculation of Break-even Sales Level (S*)Calculation of Break-even Sales Level (S*)May want to Calculate the Break-even Sales Level (S*)
for the entire firm with many productsCalculate for Income Statement at one Sales Level
S* = F 1 - VC
SS = Dollar Level of SalesVC = Total Dollar Variable Costs
![Page 37: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/37.jpg)
38Break-even AnalysisBreak-even Analysis
Calculation of Break-even Sales Level (S*)Calculation of Break-even Sales Level (S*)May want to Calculate the Break-even Sales Level (S*)
for the entire firm with many productsCalculate for Income Statement at one Sales Level
S* =
S* =$3,000,000
F 1 - VC
SS = Dollar Level of Sales = $3,000,000VC = Total Dollar Variable Costs = $1,500,000
Example:Example:
$1,000,000 1 – $1,500,000
![Page 38: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/38.jpg)
39Break-even AnalysisBreak-even Analysis
Calculation of Break-even Sales Level (S*)Calculation of Break-even Sales Level (S*)May want to Calculate the Break-even Sales Level (S*)
for the entire firm with many productsCalculate for Income Statement at one Sales Level
S* =
S* =$3,000,000
F 1 - VC
SS = Dollar Level of Sales = $3,000,000VC = Total Dollar Variable Costs = $1,500,000
Example:Example:
$1,000,000 1 – $1,500,000 = $2,000,000
![Page 39: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/39.jpg)
40Break-even AnalysisBreak-even Analysis
Graphical Analysis of Break-even PointGraphical Analysis of Break-even Point
Quantity of Units
Sales &
Costs$
Fixed Costs$1,000,000
![Page 40: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/40.jpg)
41Break-even AnalysisBreak-even Analysis
Graphical Analysis of Break-even PointGraphical Analysis of Break-even Point
Quantity of Units
Sales &
Costs$
Fixed Costs$1,000,000
Variable Costs
![Page 41: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/41.jpg)
42Break-even AnalysisBreak-even Analysis
Graphical Analysis of Break-even PointGraphical Analysis of Break-even Point
Quantity of Units
Sales &
Costs$
Fixed Costs$1,000,000
Variable Costs
Total Costs
![Page 42: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/42.jpg)
43Break-even AnalysisBreak-even Analysis
Graphical Analysis of Break-even PointGraphical Analysis of Break-even Point
Quantity of Units
Sales &
Costs$
Fixed Costs
Variable Costs
$1,000,000
Total Costs
Sales
![Page 43: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/43.jpg)
44Break-even AnalysisBreak-even Analysis
Graphical Analysis of Break-even PointGraphical Analysis of Break-even Point
Quantity of Units
Sales &
Costs$
Fixed Costs
Variable Costs
$1,000,000
Total Costs
Sales
QB = 2,500
$2,000,000
![Page 44: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/44.jpg)
45Break-even AnalysisBreak-even Analysis
Limitations:Limitations:1.1. The sales-volume-cost-profit relationship is The sales-volume-cost-profit relationship is
assumed to be linear—it may not be. In the real assumed to be linear—it may not be. In the real world It is not, except for a small range of sales.world It is not, except for a small range of sales.
2.2. Cost-price structure of the firm is assumed to Cost-price structure of the firm is assumed to remains constant. It generally does not.remains constant. It generally does not.
3.3. Sales price per unit is assumed to be constant Sales price per unit is assumed to be constant regardless of the output. This is not the case in the regardless of the output. This is not the case in the real world—you have to ? Price if you want to sell real world—you have to ? Price if you want to sell more.more.
![Page 45: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/45.jpg)
46Operating LeverageOperating Leverage
Degree of Operating LeverageDegree of Operating Leverage
• With With FIXEDFIXED operating costs, there will be operating operating costs, there will be operating leverageleverage
• DOL measures the sensitivity of EBIT to changes in sales. DOL of a company is different at different levels of sales.
• High DOL implies that a relatively small change in sales will result in large change in the operating income (EBIT)
![Page 46: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/46.jpg)
47Operating LeverageOperating Leverage
Degree of Operating LeverageDegree of Operating LeverageOperating Leverage is responsiveness of a firm’s EBIT
to fluctuations in Sales
![Page 47: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/47.jpg)
48Operating LeverageOperating Leverage
Degree of Operating LeverageDegree of Operating LeverageOperating Leverage is responsiveness of a firm’s EBIT
to fluctuations in SalesDegree of Operating Leverage (DOL)
Measurement of Operating LeverageFor a unique level of sales, DOL changes as sales
change.
![Page 48: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/48.jpg)
49Operating LeverageOperating Leverage
Degree of Operating LeverageDegree of Operating LeverageOperating Leverage is responsiveness of a firm’s EBIT
to fluctuations in SalesDegree of Operating Leverage (DOL)
Measurement of Operating LeverageFor a unique level of sales, DOL changes as sales
change.
DOLS = % Change in EBIT % Change in Sales
Unique Level of SalesUnique Level of Sales
![Page 49: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/49.jpg)
50Operating LeverageOperating Leverage
Measurement of DOLMeasurement of DOLCalculation using per unit information:
DOLS = Q(P – V)
Q(P – V) – F
![Page 50: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/50.jpg)
51Operating LeverageOperating Leverage
Measurement of DOLMeasurement of DOLCalculation using per unit information:
DOLS = Q(P – V)
Q(P – V) – F
Q = 3,750 unitsPrice = $800 per unit
Variable costs = $400 per unit Fixed Costs = $1,000,000 per year.
Example:Example:
![Page 51: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/51.jpg)
52Operating LeverageOperating Leverage
Measurement of DOLMeasurement of DOLCalculation using per unit information:
DOLS = Q(P – V)
Q(P – V) – F
Q = 3,750 unitsPrice = $800 per unit
Variable costs = $400 per unit Fixed Costs = $1,000,000 per year.
Example:Example:
DOL3,750 units = 3,750(800 – 400) 3,750(800 – 400) – 1,000,000
![Page 52: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/52.jpg)
53Operating LeverageOperating Leverage
Measurement of DOLMeasurement of DOLCalculation using per unit information:
DOLS = Q(P – V)
Q(P – V) – F
Q = 3,750 unitsPrice = $800 per unit
Variable costs = $400 per unit Fixed Costs = $1,000,000 per year.
Example:Example:
DOL3,750 units = 3,750(800 – 400) 3,750(800 – 400) – 1,000,000
= 3 times
![Page 53: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/53.jpg)
54Operating LeverageOperating Leverage
Measurement of DOLMeasurement of DOLCalculation using per unit information:
DOLS = Q(P – V)
Q(P – V) – F
Q = 3,750 unitsPrice = $800 per unit
Variable costs = $400 per unit Fixed Costs = $1,000,000 per year.
Example:Example:
DOL3,750 units = 3,750(800 – 400) 3,750(800 – 400) – 1,000,000
= 3 times Interpretation: If sales change 1%, then EBIT will change 3% in the same direction.
Interpretation: If sales change 1%, then EBIT will change 3% in the same direction.
![Page 54: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/54.jpg)
55Operating LeverageOperating Leverage
Measurement of DOLMeasurement of DOLCalculation using Income Statement Information
DOLS = S – VC
S – VC – F
![Page 55: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/55.jpg)
56Operating LeverageOperating Leverage
Measurement of DOLMeasurement of DOLCalculation using Income Statement Information
DOLS = S – VC
S – VC – F
Q = 3,750 unitsPrice = $800 per unit
Variable costs = $400 per unit Fixed Costs = $1,000,000 per year.
Example:Example:
![Page 56: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/56.jpg)
57Operating LeverageOperating Leverage
Measurement of DOLMeasurement of DOLCalculation using Income Statement Information
DOLS = S – VC
S – VC – F
Q = 3,750 unitsPrice = $800 per unit
Variable costs = $400 per unit Fixed Costs = $1,000,000 per year.
Example:Example: SalesSales$3,000,000
SalesSales$3,000,000x
![Page 57: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/57.jpg)
58Operating LeverageOperating Leverage
Measurement of DOLMeasurement of DOLCalculation using Income Statement Information
DOLS = S – VC
S – VC – F
Q = 3,750 unitsPrice = $800 per unit
Variable costs = $400 per unit Fixed Costs = $1,000,000 per year.
Example:Example:
Variable CostsVariable Costs$1,500,000
Variable CostsVariable Costs$1,500,000x
![Page 58: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/58.jpg)
59Operating LeverageOperating Leverage
Measurement of DOLMeasurement of DOLCalculation using Income Statement Information
DOLS = S – VC
S – VC – F
Q = 3,750 unitsPrice = $800 per unit
Variable costs = $400 per unit Fixed Costs = $1,000,000 per year.
Example:Example:
DOL3,750 units = 3,000,000 – 1,500,00 3,000,000 – 1,500,000 – 1,000,000
![Page 59: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/59.jpg)
60Operating LeverageOperating Leverage
Measurement of DOLMeasurement of DOLCalculation using Income Statement Information
DOLS = S – VC
S – VC – F
Q = 3,750 unitsPrice = $800 per unit
Variable costs = $400 per unit Fixed Costs = $1,000,000 per year.
Example:Example:
DOL3,750 units = 3,000,000 – 1,500,00 3,000,000 – 1,500,000 – 1,000,000
= 3 times
![Page 60: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/60.jpg)
61Operating LeverageOperating Leverage
Measurement of DOLMeasurement of DOLCalculation using Income Statement Information
DOLS = S – VC
S – VC – F
Q = 3,750 unitsPrice = $800 per unit
Variable costs = $400 per unit Fixed Costs = $1,000,000 per year.
Example:Example:
DOL3,750 units = 3,000,000 – 1,500,00 3,000,000 – 1,500,000 – 1,000,000
= 3 times Same Answer as beforeSame Answer as before
![Page 61: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/61.jpg)
62Operating LeverageOperating Leverage
Degree of Operating LeverageDegree of Operating LeverageDegree of Operating Leverage is highest when the firm
is closest to break-even point--DOL falls as sales rise
Quantity DOL2,500 (QB) Undefined3,250 4.333,750 35,000 2
![Page 62: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/62.jpg)
63Operating LeverageOperating Leverage
Degree of Operating LeverageDegree of Operating LeverageDegree of Operating Leverage is highest when the firm
is closest to break-even point--DOL falls as sales riseQuantity DOL2,500 (QB) Undefined3,250 4.333,750 35,000 2
The higher the sales level above break-even, the less EBIT (in %) changes as sales change
![Page 63: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/63.jpg)
64Operating LeverageOperating Leverage
Degree of Operating LeverageDegree of Operating LeverageDegree of Operating Leverage is highest when the firm
is closest to break-even point--DOL falls as sales riseQuantity DOL2,500 (QB) Undefined3,250 4.333,750 35,000 2
The higher the sales level above break-even, the less EBIT(in %) changes as sales change
If Fixed Costs = $0, Degree of Operating Leverage = 1
![Page 64: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/64.jpg)
65Financial LeverageFinancial Leverage
Degree of Financial LeverageDegree of Financial LeverageFinance a portion of the firm’s assets with securities
that have fixed financial costsDebtPreferred Stock
![Page 65: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/65.jpg)
66Financial LeverageFinancial Leverage
Degree of Financial LeverageDegree of Financial LeverageFinance a portion of the firm’s assets with securities
that have fixed financial costsDebtPreferred Stock
Financial Leverage measures changes in earnings per share (NI) as EBIT changes.
![Page 66: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/66.jpg)
67Financial LeverageFinancial Leverage
Degree of Financial LeverageDegree of Financial LeverageFinance a portion of the firm’s assets with securities
that have fixed financial costsDebtPreferred Stock
Financial Leverage measures changes in earnings per share as EBIT changes.
Degree of Financial Leverage (DFL) at one level of EBIT:
DFLEBIT = % Change in EPS % Change in EBIT
Unique Level of EBITUnique Level of EBIT
![Page 67: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/67.jpg)
68Financial LeverageFinancial Leverage
DFLEBIT = EBIT EBIT – I
Measurement of DFLMeasurement of DFL
![Page 68: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/68.jpg)
69Financial LeverageFinancial Leverage
DFLEBIT = EBIT EBIT – I
Measurement of DFLMeasurement of DFL
Total Fixed FinancingCosts
Total Fixed FinancingCosts
![Page 69: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/69.jpg)
70Financial LeverageFinancial Leverage
DFLEBIT = EBIT EBIT – I
EBIT = $500,000Interest Charges = $200,000
Example:Example:
Measurement of DFLMeasurement of DFL
![Page 70: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/70.jpg)
71Financial LeverageFinancial Leverage
DFLEBIT = EBIT EBIT – I
EBIT = $500,000Interest Charges = $200,000
Example:Example:
DFLEBIT=500,000 = 500,000 500,000 – 200,000
Measurement of DFLMeasurement of DFL
![Page 71: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/71.jpg)
72Financial LeverageFinancial Leverage
DFLEBIT = EBIT EBIT – I
EBIT = $500,000Interest Charges = $200,000
Example:Example:
DFLEBIT=500,000 = 500,000 500,000 – 200,000
= 1.67 times
Measurement of DFLMeasurement of DFL
![Page 72: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/72.jpg)
73Financial LeverageFinancial Leverage
DFLEBIT = EBIT EBIT – I
EBIT = $500,000Interest Charges = $200,000
Example:Example:
DFLEBIT=500,000 = 500,000 500,000 – 200,000
= 1.67 times
Measurement of DFLMeasurement of DFL
Interpretation: For 1% change in EBIT (from an existing level of $500,000) Earnings Per Share will change 1.67%
Interpretation: For 1% change in EBIT (from an existing level of $500,000) Earnings Per Share will change 1.67%
![Page 73: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/73.jpg)
74DFLDFL
S - VC - FS - VC - FDFL = ---------------------DFL = --------------------- S - VC - F - IS - VC - F - I
![Page 74: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/74.jpg)
75Combined LeverageCombined Leverage
Degree of Combined LeverageDegree of Combined LeverageMeasures changes in Earnings Per Share given
changes in Sales
![Page 75: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/75.jpg)
76Combined LeverageCombined Leverage
Degree of Combined LeverageDegree of Combined LeverageMeasures changes in Earnings Per Share given
changes in SalesCombines both Operating and Financial Leverage
![Page 76: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/76.jpg)
77Combined LeverageCombined Leverage
Degree of Combined LeverageDegree of Combined LeverageMeasures changes in Earnings Per Share given
changes in SalesCombines both Operating and Financial LeverageComputed for a specific level of sales
![Page 77: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/77.jpg)
78Combined LeverageCombined Leverage
DCLS = % Change in EPS % Change in Sales
Degree of Combined LeverageDegree of Combined LeverageMeasures changes in Earnings Per Share given
changes in SalesCombines both Operating and Financial LeverageComputed for a specific level of sales
Unique Level of SalesUnique Level of Sales
![Page 78: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/78.jpg)
79Combined LeverageCombined Leverage
DCLS = DOLS x DFLEBIT
Measurement of DCLMeasurement of DCL
![Page 79: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/79.jpg)
80Combined LeverageCombined Leverage
DCLS = DOLS x DFLEBIT
DFLEBIT = 1.67 DOLS = 3.0
Example:Example:
Measurement of DCLMeasurement of DCL
![Page 80: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/80.jpg)
81Combined LeverageCombined Leverage
DCLS = DOLS x DFLEBIT
DFLEBIT = 1.67 DOLS = 3.0
Example:Example:
Measurement of DCLMeasurement of DCL
DCL3,750 = 3.0 x 1.67
![Page 81: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/81.jpg)
82Combined LeverageCombined Leverage
DCLS = DOLS x DFLEBIT
DFLEBIT = 1.67 DOLS = 3.0
Example:Example:
= 5.0 times
Measurement of DCLMeasurement of DCL
DCL3,750 = 3.0 x 1.67
![Page 82: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/82.jpg)
83Combined LeverageCombined Leverage
DCLS = DOLS x DFLEBIT
DFLEBIT = 1.67 DOLS = 3.0
Example:Example:
= 5.0 times
Measurement of DCLMeasurement of DCL
Interpretation: When sales change 1%, Earnings Per Share (NI) will change 5.0%
Interpretation: When sales change 1%, Earnings Per Share (NI) will change 5.0%
DCL3,750 = 3.0 x 1.67
![Page 83: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/83.jpg)
84Combined LeverageCombined Leverage
DCLS =
Measurement of DCL--Alternative ComputationMeasurement of DCL--Alternative Computation
Q(P – V) Q(P – V) – F – I
![Page 84: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/84.jpg)
85Combined LeverageCombined Leverage
DCLS =
Measurement of DCL--Alternative ComputationMeasurement of DCL--Alternative Computation
Q(P – V) Q(P – V) – F – I
Q = 3,750 unitsPrice = $800 per unit
Variable costs = $400 per unit Fixed Costs = $1,000,000 per year
Interest = $200,000 per year
Example:Example:
![Page 85: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/85.jpg)
86Combined LeverageCombined Leverage
DCLS =
Measurement of DCL--Alternative ComputationMeasurement of DCL--Alternative Computation
Q(P – V) Q(P – V) – F – I
Q = 3,750 unitsPrice = $800 per unit
Variable costs = $400 per unit Fixed Costs = $1,000,000 per year
Interest = $200,000 per year
Example:Example:
DCLS = 3,750(800 – 400) 3,750(800 – 400) – 1,000,000 – 200,000
![Page 86: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/86.jpg)
87Combined LeverageCombined Leverage
DCLS =
Measurement of DCL--Alternative ComputationMeasurement of DCL--Alternative Computation
Q(P – V) Q(P – V) – F – I
Q = 3,750 unitsPrice = $800 per unit
Variable costs = $400 per unit Fixed Costs = $1,000,000 per year
Interest = $200,000 per year
Example:Example:
DCLS = 3,750(800 – 400) 3,750(800 – 400) – 1,000,000 – 200,000
= 5 times
![Page 87: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/87.jpg)
88Combined LeverageCombined Leverage
DCLS =
Measurement of DCL--Alternative ComputationMeasurement of DCL--Alternative Computation
Interpretation: When sales change 1%, Earnings Per Share will change 5.0%
Interpretation: When sales change 1%, Earnings Per Share will change 5.0%
Q(P – V) Q(P – V) – F – I
Q = 3,750 unitsPrice = $800 per unit
Variable costs = $400 per unit Fixed Costs = $1,000,000 per year
Interest = $200,000 per year
Example:Example:
DCLS = 3,750(800 – 400) 3,750(800 – 400) – 1,000,000 – 200,000
= 5 times
![Page 88: Analysis and Impact of Leverage](https://reader030.vdocument.in/reader030/viewer/2022032612/56812dd0550346895d93126c/html5/thumbnails/88.jpg)
89
S - VC - FS - VC - FDCLDCLSS = --------------------- = ---------------------
S - VC - F - IS - VC - F - I
Combined Leverage
Measurement of DCL--Alternative Computation-Measurement of DCL--Alternative Computation- Using income statement.Using income statement.