TAILIEUCHUNG - Lecture Corporate finance: A practical approach: Chapter 4 - CFA Institute
Leverage is the use of fixed costs relative to variable costs. Operating leverage pertains to the mix of fixed and variable costs of production. Financial leverage pertains to the capital structure (how the company finances its business). This chapter define and explain leverage, business risk, sales risk, operating risk, and financial risk and classify a risk, given a description. | Chapter 4 Measures of leverage Presenter’s name Presenter’s title dd Month yyyy 1 1. Introduction Leverage is the use of fixed costs in a company’s cost structure. Operating leverage relates to the company’s operating cost structure. Financial leverage relates to the company’s capital structure. Copyright © 2013 CFA Institute 2 Fixed Costs Fixed Costs LOS: Define and explain leverage, business risk, sales risk, operating risk, and financial risk and classify a risk, given a description. Page 171 Introduction Leverage is the use of fixed costs relative to variable costs. Operating leverage pertains to the mix of fixed and variable costs of production. Financial leverage pertains to the capital structure (how the company finances its business). 2 Why worry about leverage? A company’s use of leverage affects its risk and return. Operating leverage and financial leverage provide insight into a company’s business and its future. Leverage helps us understand a company’s future cash flows and the risk associated with those cash flows and, hence, its valuation. Copyright © 2013 CFA Institute 3 Pages 172–173 Why Worry About Leverage? From an analyst point of view, leverage affects the company’s risk (both total and systematic). 3 2. Leverage Copyright © 2013 CFA Institute 4 Leverage increases the volatility of earnings and cash flows → hence, it increases risk to suppliers of capital (creditors and owners). Consider two companies, Company One and Company Two, with the following information: Company One Company Two Number of units produced and sold 1,000 1,000 Sales price per unit €250 €250 Variable cost per unit €125 €25 Fixed operating cost €50,000 €100,000 Fixed financing expense €5,000 €55,000 Debt €50,000 €550,000 Equity €700,000 €200,000 Total assets €750,000 €750,000 LOS: Define and explain leverage, business risk, sales risk, operating risk, and financial risk and classify a risk, given a description. Pages 172–173 2. Leverage Leverage is the use of fixed costs in .
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