# FINC-212 Lecture Notes - Lecture 9: Operating Leverage, Weighted Arithmetic Mean, Fixed Cost

by OC3480101

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**preview**shows half of the first page. to view the full**3 pages of the document.**Determinants of Beta

- Product Type

o Industry Effects: The beta depends on the sensitivity of demand for its

products/services, and of its costs to macroeconomic factors

▪ Cyclical companies have higher betas than non-cyclical firms

▪ Firms that sell more discretionary products have higher betas

- Operating Leverage

o Higher operating leverage results in greater earnings variability, which results in

higher betas

o Fixed Costs Measure = Fixed Costs / Variable Costs

▪ Measures the relationship between fixed and variable costs

▪ The higher the proportion, the higher the operating leverage

o EBIT Variability Measure = % Change in EBIT / % Change in Revenues

▪ Measures how quickly EBIT changes as revenue changes

▪ The higher the number, the greater the operating leverage

- Financial Leverage

o More financial leverage means higher fixed costs, which makes their earnings to

equity investors more volatile – increases earnings volatility, increasing beta

o 𝛽L = 𝛽U [1+ ((1-t)D/E)]

▪ 𝛽L = Levered or Equity Beta

▪ 𝛽U = Unlevered or Asset Beta

Qualities of Beta

- Beta of a Portfolio is always the market-value weighted average of the betas of the

individual investments in that portfolio

o The beta of a mutual fund is the weighted average of the betas of the stocks and

other investments in that portfolio

o The beta of a firm after a merger is the market-value weighted average of the

betas of the companies involved in the merger

- Firm Beta vs. Divisional Beta

o A firm’s beta is the weighted average of its division’s betas

o Divisional betas are weighted averages of its individual project’s betas

- Bottom-up vs. Top-down Beta

o Top-down beta for a firm comes from regression

o Bottom-up beta can be estimated by doing the following

▪ Find out the businesses that a firm operates in

▪ Find the unlevered betas of the other firms in these businesses

▪ (remove the effects of cash on the beta)

▪ Take the average (or median) beta

▪ Lever up using the firm’s D/E ratio

o Bottom-up beta is more accurate because

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