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. 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. | Operating Leverage Financial Leverage Ch. 15: Analysis and Impact of Leverage 2002, Prentice Hall, Inc. What is Leverage? What is Leverage? What is Leverage? 2 concepts that enhance our understanding of risk. 1) Operating Leverage - affects a firm’s business risk. 2) Financial Leverage - affects a firm’s financial risk. Business Risk The variability or uncertainty of a firm’s operating income (EBIT). Business Risk The variability or uncertainty of a firm’s operating income (EBIT). EBIT Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock- holders Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock- holders Business Risk Affected by: Sales volume variability Competition Cost variability Product diversification Product demand Operating Leverage 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. EBIT Operating Leverage 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. 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. FIRM EBIT EPS Stock- holders 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. FIRM EBIT EPS Stock- holders Financial Leverage The use of fixed-cost sources of financing (debt, preferred stock) rather than variable-cost sources (common stock). EPS | Operating Leverage Financial Leverage Ch. 15: Analysis and Impact of Leverage 2002, Prentice Hall, Inc. What is Leverage? What is Leverage? What is Leverage? 2 concepts that enhance our understanding of risk. 1) Operating Leverage - affects a firm’s business risk. 2) Financial Leverage - affects a firm’s financial risk. Business Risk The variability or uncertainty of a firm’s operating income (EBIT). Business Risk The variability or uncertainty of a firm’s operating income (EBIT). EBIT Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock- holders Business Risk The variability or uncertainty of a firm’s operating income (EBIT). FIRM EBIT EPS Stock- holders Business Risk Affected by: Sales volume variability Competition Cost variability Product .
