1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a...
-
Upload
ashlee-little -
Category
Documents
-
view
223 -
download
0
Transcript of 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a...
![Page 1: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/1.jpg)
1
• Operating Leverage
• Financial Leverage
![Page 2: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/2.jpg)
2
Business Risk
• The variability or uncertainty of a firm’s operating income (EBIT).
FIRMFIRMEBIT EPSStock-Stock-holdersholders
![Page 3: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/3.jpg)
3
Business Risk
Affected by:
• Sales volume variability
• Competition
• Cost variability
• Product diversification
• Product demand
• Operating Leverage
![Page 4: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/4.jpg)
4
Operating Leverage
• The use of fixed operating costs as opposed to variable operating costs.
• A firm with relatively high fixed operating costs will experience more variable operating income if sales change.
![Page 5: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/5.jpg)
5
Financial Risk
• The variability or uncertainty of a firm’s earnings per share (EPS) and the increased probability of insolvency that arises when a firm uses financial leverage.
FIRMFIRMEBIT EPSStock-Stock-holdersholders
![Page 6: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/6.jpg)
6
Financial Leverage
• The use of fixed-cost sources of financing (debt, preferred stock) rather than variable-cost sources (common stock).
• A firm with relatively high fixed financing costs will experience more net income if EBIT changes.
![Page 7: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/7.jpg)
7
Costs
• Suppose the firm has both fixed operating costs (administrative salaries, insurance, rent, property tax) and variable operating costs (materials, labor, energy, packaging, sales commissions).
![Page 8: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/8.jpg)
8
Operating Leverage
• What happens if the firm increases its fixed operating costs and reduces (or eliminates) its variable costs?
![Page 9: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/9.jpg)
9
With high operating leverage, an increase in sales
produces a relatively larger increase in operating
income.
![Page 10: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/10.jpg)
10
Trade-off: Trade-off: the firm hasthe firm has
a higher breakeven a higher breakeven point. If sales are not point. If sales are not high enough, the firm high enough, the firm will not meet its fixedwill not meet its fixed
expenses!expenses!
![Page 11: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/11.jpg)
11
Breakeven point (units of output)
• QB = breakeven level of Q.
• F = total anticipated fixed costs.
• P = sales price per unit.
• V = variable cost per unit.
Breakeven Calculations
QB = FP - V
![Page 12: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/12.jpg)
12
Breakeven point (sales dollars)
• S* = breakeven level of sales.
• F = total anticipated fixed costs.
• S = total sales.
• VC = total variable costs.
Breakeven Calculations
S* = F VC S
1 -
![Page 13: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/13.jpg)
13
Degree of Operating Leverage (DOL)
• Operating leverage: by using fixed operating costs, a small change in sales revenue is magnified into a larger change in operating income.
• This “multiplier effect” is called the degree of operating leverage.
![Page 14: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/14.jpg)
14
DOLs = % change in EBIT% change in sales
=
Degree of Operating Leveragefrom Sales Level (S)
Sales - Variable Costs EBIT
Q(P - V) Q(P - V) - F=
![Page 15: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/15.jpg)
15
What does this tell us?
• If DOL = 2, then a 1% increase in sales will result in a 2% increase in operating income (EBIT).
Stock-holdersEBIT EPSSales
![Page 16: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/16.jpg)
16
Degree of Financial Leverage (DFL)
• Financial leverage: by using fixed cost financing, a small change in operating income is magnified into a larger change in earnings per share.
• This “multiplier effect” is called the degree of financial leverage.
![Page 17: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/17.jpg)
17
DFL = % change in EPS% change in EBIT
EBIT EBIT - I
Degree of Financial Leverage
=
![Page 18: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/18.jpg)
18
What does this tell us?
• If DFL = 3, then a 1% increase in operating income will result in a 3% increase in earnings per share.
Stock-holdersEBIT EPSSales
![Page 19: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/19.jpg)
19
Degree of Combined Leverage (DCL)
• Combined leverage: by using operating leverage and financial leverage, a small change in sales is magnified into a larger change in earnings per share.
• This “multiplier effect” is called the degree of combined leverage.
![Page 20: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/20.jpg)
20
DCL = DOL x DFL
Degree of Combined Leverage
=% change in EPS% change in Sales
Sales - Variable Costs EBIT - I
=
=
Q(P - V) Q(P - V) - F - I
![Page 21: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/21.jpg)
21
What does this tell us?
• If DCL = 4, then a 1% increase in sales will result in a 4% increase in earnings per share.
Stock-holdersEBIT EPSSales
![Page 22: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/22.jpg)
22
In-class Project:
• Based on the following information on Levered Company, answer these questions:
1) If sales increase by 1%, what should happen to operating income?
2) If operating income increases by 1%, what should happen to EPS?
3) If sales increase by 1%, what should be the effect on EPS?
![Page 23: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/23.jpg)
23
Levered Company
Sales (100,000 units) $1,400,000
Variable Costs $800,000
Fixed Costs $250,000
Interest paid $125,000
Tax rate 34%
Common shares outstanding 100,000
![Page 24: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/24.jpg)
24
Sales
EBITEPS
DOL
DFL
DCL
Leverage
![Page 25: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/25.jpg)
25
Degree of Operating Leverage from Sales Level (S)
1,400,000 - 800,000 350,000
= 1.714
=
DOLs = Sales - Variable Costs EBIT
![Page 26: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/26.jpg)
26
Levered Company
Sales
EBITEPS
DOL = 1.714
DFL =
DCL
![Page 27: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/27.jpg)
27
Degree of Financial Leverage
DFL = EBIT EBIT - I
= 350,000 225,000
= 1.556
![Page 28: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/28.jpg)
28
Levered Company
Sales
EBITEPS
DOL = 1.714
DFL = 1.556
DCL
![Page 29: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/29.jpg)
29
Degree of Combined Leverage
DCL = Sales - Variable Costs EBIT - I
1,400,000 - 800,000 225,000
= 2.667
=
![Page 30: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/30.jpg)
30
Levered Company
Sales
EBITEPS
DOL = 1.714
DFL = 1.556
DCL= 2.667
![Page 31: 1 Operating Leverage Financial Leverage. 2 Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock-holders.](https://reader035.fdocuments.us/reader035/viewer/2022062309/56649f3a5503460f94c582b7/html5/thumbnails/31.jpg)
31
Sales (110,000 units) 1,414,000
Variable Costs (808,000)
Fixed Costs (250,000)
EBIT 356,000 ( +1.714%)
Interest (125,000)
EBT 231,000
Taxes (34%) (78,540)
Net Income 152,460
EPS $1.5246 ( +2.667%)
Levered Company1% increase in sales