Operating Leverage Q

CFA Level II
#1

Which of the following statements regarding leverage is TRUE? A) A firm with high business risk is more likely to increase its use of financial leverage than a firm with low business risk. B) A firm with low operating leverage has a small proportion of its total costs in fixed costs. C) High levels of financial leverage increase business risk while high levels of operating leverage will decrease business risk.

#2

B?

#3

A?

#4

Your answer: B was correct! A firm with high operating leverage has a high percentage of its total costs in fixed costs.

#5

B

#6

This q tripped me up. DOL = (S - TVC) / (S - TVC - F) So if this number is low, then F is relatively small and DOL is closer to 1. The numerator is close in value to the denominator. If F were large, then the numerator would be larger than the denominator leading to high DOL.

#7

This gotta be the biggest blunder to begin my day with. The answer is OBVIOUSLY B. hold tight, more to come…

#8

I think the definition of operating risk having high fixed cost and the def of financial risk having high interest cost, so you don’t even need the formula to figure it out

#9

Let’s remember these formulas, DOL = change in EBIT / change in sales DOL = Q ( P - V) / ( Q ( P - V) - F) = (S - TVC) / ( S - TVC - F) DFL = change in EPS / change in EBIT = EBIT / (EBIT - Int) DTL = DOL*DFL = change in EPS / change in sales or ( S - TVC ) / (S - TVC - F - Int) Sound about right? The

#10

its a very straightforward question. operating risk (a.k.a biz risk) is the increased volatility of operating income when fixed costs are high.

#11

Break Even Quantity = Fixed Cost / Price - Variable cost.

#12

B is the right answer.

#13

Break Even Quantity (operating) = Fixed Cost / Price - Variable cost. and Break Even Quantity (financial) = Interest Cost / Price - Variable cost.

#14

Q ( P - V) = Fixed costs Q ( P - V ) = Interest cost I didn’t know the second formula at all… The more you know…

#15

Q_oper ( P - V) = Fixed costs Q_fin ( P - V ) = Interest cost

#16

I dont remember seeing this 2nd formula? “Break Even Quantity (financial) = Interest Cost / Price - Variable cost”

#17

so, the first one tells you how many items to sell in order to cover your fixed costs, and the second one tells you how many items to sell in order to cover your interest costs.

#18

oh ok, Thanks D!

#19

there is no such thing as break even quantity financial. The only thing mentioned in the books is the breakeven quantity total = (Fixed + Interest) / (Price - Variable).