B A 323 Lecture Notes - Lecture 13: Operating Leverage, Capital Structure, Fixed Cost
Document Summary
Business risk - riskiness inherent in the firm"s operations if it uses no debt. Commonly used measures of business risk is roic. Roic - measures the after-tax return that the company provides for all its investors. Does not vary with changes in capital structure. Roic = ebit (1 t) / total invested capital. Operating leverage - use of fixed costs rather than variable costs. Fixed cost - pay regardless of how much you sell. Variable cost - dependent on how many sales you make. If most costs are fixed, hence do not decline when demand falls, then the firm has high operating leverage. Airlines: great example of high operating leverage because they have high fixed costs. Why they need financial assistance from the government. More operating leverage leads to more business risk, for then a small sales decline causes a big profit decline. Financial leverage - use of debt and preferred stock.
