Leverage

Summaries

Leverage – amount of fixed cost the firm has

Business risk is the risk associated with the operating income, so it is a combination of sales risk and operating risk!

Risks:

1. Sales risk
2. Operating risk – high DOL
3. Financial risk

Degree of Operating Leverage (DOL)

= D_EBIT% / D_Q%

= (S – TVC) / (S- TCV – FC)

Degree of Financial Leverage (DOF)

=D_net_income% / D_EBIT%

= (EBIT) / (EBIT  – Interest)

Degree of total leverage DTL

= DOL x DOF

= (S – VC) / (S – VC – FC – I)

Breakeven quantity Q = FC/ (P-VC)

WACC = r_d*(1-t)*debt/asset + r_e*equity/asset