【財務(wù)管理英文課件】Operating-and-Financial-Leverage

Chapter16OperatingandFinancialLeverageChapter16OperatingandFinancOperatingandFinancialLeverageOperatingLeverageFinancialLeverageTotalLeverageCash-FlowAbilitytoServiceDebtOtherMethodsofAnalysisCombinationofMethodsOperatingandFinancialLeveraOperatingLeverageOnepotentialeffectcausedbythepresenceofoperatingleverageisthatachangeinthevolumeofsalesresultsinamorethanproportionalchangeinoperatingprofit(orloss).OperatingLeverage--Theuseoffixedoperatingcostsbythefirm.OperatingLeverageOnepotentiaImpactofOperatingLeverageonProfits

FirmFFirmVFirm2FSales $10 $11 $19.5OperatingCosts Fixed 7 2 14Variable 2 7 3OperatingProfit

$

1 $2 $2.5 FC/totalcosts .78 .22 .82FC/sales .70 .18 .72(inthousands)ImpactofOperatingLeverageoImpactofOperatingLeverageonProfitsNow,subjecteachfirmtoa50%increaseinsalesfornextyear.WhichfirmdoyouthinkwillbemoreSensitivetothechangeinsales(i.e.,showthelargestpercentagechangeinoperatingprofit,EBIT)?[]FirmF;[]FirmV;[]Firm2F.ImpactofOperatingLeverageoImpactofOperatingLeverageonProfits

FirmFFirmVFirm2FSales $15 $16.5 $29.25OperatingCosts

Fixed 7 2 14Variable 3 10.5 4.5OperatingProfit

$

5 $4 $10.75Percentage ChangeinEBIT* 400%100%330%(inthousands)*(EBITt-EBITt-1)/EBITt-1ImpactofOperatingLeverageoImpactofOperatingLeverageonProfitsFirmFisthemostSensitivefirm--forit,a50%increaseinsalesleadstoa400%increaseinEBIT.Ourexamplerevealsthatitisamistaketoassumethatthefirmwiththelargestabsoluteorrelativeamountoffixedcostsautomaticallyshowsthemostdramaticeffectsofoperatingleverage.Later,wewillcomeupwithaneasywaytospotthefirmthatismostsensitivetothepresenceofoperatingleverage.ImpactofOperatingLeverageoBreak-EvenAnalysisWhenstudyingoperatingleverage,profitsreferstooperatingprofitsbeforetaxes(i.e.,EBIT)andexcludesdebtinterestanddividendpayments.Break-EvenAnalysis--Atechniqueforstudyingtherelationshipamongfixedcosts,variablecosts,profits,andsalesvolume.Break-EvenAnalysisWhenstudyiBreak-EvenChartQUANTITYPRODUCEDANDSOLD01,0002,0003,0004,0005,0006,0007,000TotalRevenuesProfitsFixedCostsVariableCostsLossesREVENUESANDCOSTS($thousandsotalCostsBreak-EvenChartQUANTITYPRODUBreak-Even(Quantity)Point

Howtofindthequantitybreak-evenpoint: EBIT=P(Q)-V(Q)-FC EBIT=Q(P-V)-FCP=Priceperunit

V=VariablecostsperunitFC=Fixedcosts Q=Quantity(units) producedandsoldBreak-EvenPoint--Thesalesvolumerequiredsothattotalrevenuesandtotalcostsareequal;maybeinunitsorinsalesdollars.Break-Even(Quantity)Point HoBreak-Even(Quantity)PointBreak-evenoccurswhenEBIT=0

Q(P-V)-FC =EBIT

QBE(P-V)-FC =0

QBE(P-V) =FC

QBE =FC

/(P-V)Break-Even(Quantity)PointBreBreak-Even(Sales)PointHowtofindthesalesbreak-evenpoint:

SBE

=

FC+(VCBE)

SBE

=

FC+(QBE)(V)

or

SBE* =

FC/[1-(VC/S)]*RefertotextforderivationoftheformulaBreak-Even(Sales)PointHowtoBreak-EvenPointExample

BasketWonders(BW)wantstodetermineboththequantityandsalesbreak-evenpointswhen:Fixedcostsare$100,000Basketsaresoldfor$43.75

eachVariablecostsare$18.75perbasketBreak-EvenPointExample BaskeBreak-EvenPoint(s)Break-evenoccurswhen:

QBE =FC

/(P-V)

QBE =$100,000

/($43.75-$18.75)

QBE =4,000Units SBE

=

(QBE)(V)+FC SBE

=

(4,000)($18.75)+$100,000

SBE =$175,000Break-EvenPoint(s)Break-evenBreak-EvenChartQUANTITYPRODUCEDANDSOLD01,0002,0003,0004,0005,0006,0007,000TotalRevenuesProfitsFixedCostsVariableCostsLossesREVENUESANDCOSTS($thousandsotalCostsBreak-EvenChartQUANTITYPRODUDegreeofOperatingLeverage(DOL)DOLatQunitsofoutput(orsales)DegreeofOperatingLeverage--Thepercentagechangeinafirm’soperatingprofit(EBIT)resultingfroma1percentchangeinoutput(sales).=Percentagechangeinoperatingprofit(EBIT)Percentagechangeinoutput(orsales)DegreeofOperatingLeverage(ComputingtheDOLDOLQunitsCalculatingtheDOLforasingleproductorasingle-productfirm.=Q(P-V)Q(P-V)-FC=QQ-QBEComputingtheDOLDOLQunitsCalComputingtheDOLDOLSdollarsofsalesCalculatingtheDOLforamultiproductfirm.=S-VCS-VC-FC=EBIT+FCEBITComputingtheDOLDOLSdollarsBreak-EvenPointExample

LisaMillerwantstodeterminethedegreeofoperatingleverageatsaleslevelsof6,000and8,000units.Aswedidearlier,wewillassumethat:Fixedcostsare$100,000Basketsaresoldfor$43.75

eachVariablecostsare$18.75perbasketBreak-EvenPointExample LisaComputingBW’sDOLDOL6,000unitsComputationbasedonthepreviouslycalculatedbreak-evenpointof4,000units=6,0006,000-4,000==3DOL8,000units8,0008,000-4,000=2ComputingBW’sDOLDOL6,000uniInterpretationoftheDOLA1%increaseinsalesabovethe8,000unitlevelincreasesEBITby2%becauseoftheexistingoperatingleverageofthefirm.=DOL8,000units8,0008,000-4,000=2InterpretationoftheDOLA1%InterpretationoftheDOL2,0004,0006,0008,00012345QUANTITYPRODUCEDANDSOLD0-1-2-3-4-5DEGREEOFOPERATINGLEVERAGE(DOL)QBEInterpretationoftheDOL2,000InterpretationoftheDOLDOLisaquantitativemeasureofthesensitivityofafirm’soperatingprofittoachangeinthefirm’ssales.Thecloserthatafirmoperatestoitsbreak-evenpoint,thehigheristheabsolutevalueofitsDOL.Whencomparingfirms,thefirmwiththehighestDOListhefirmthatwillbemostsensitivetoachangeinsales.KeyConclusionstobeDrawnfromslide16-22andourDiscussionofDOLInterpretationoftheDOLDOLiDOLandBusinessRiskDOLisonlyonecomponentofbusinessriskandbecomesactiveonlyinthepresenceofsalesandproductioncostvariability.DOLmagnifiesthevariabilityofoperatingprofitsand,hence,businessrisk.BusinessRisk--Theinherentuncertaintyinthephysicaloperationsofthefirm.Itsimpactisshowninthevariabilityofthefirm’soperatingincome(EBIT).DOLandBusinessRiskDOLisonFinancialLeverageFinancialleverageisacquiredbychoice.Usedasameansofincreasingthereturntocommonshareholders.FinancialLeverage--Theuseoffixedfinancingcostsbythefirm.TheBritishexpressionisgearing.FinancialLeverageFinancialleEBIT-EPSBreak-Even,orIndifference,AnalysisCalculateEPSforagivenlevelofEBITatagivenfinancingstructure.EBIT-EPSBreak-EvenAnalysis--Analysisoftheeffectoffinancingalternativesonearningspershare.Thebreak-evenpointistheEBITlevelwhereEPSisthesamefortwo(ormore)alternatives.(EBIT-I)(1-t)-Pref.Div.#ofCommonSharesEPS=EBIT-EPSBreak-Even,orIndiffEBIT-EPSChartCurrentcommonequityshares=50,000$1millioninnewfinancingofeither:AllC.S.soldat$20/share(50,000shares)Alldebtwithacouponrateof10%AllP.S.withadividendrateof9%ExpectedEBIT=$500,000Incometaxrateis30%BasketWondershas$2millioninLTfinancing(100%commonstockequity).EBIT-EPSChartCurrentcommoneEBIT-EPSCalculationwithNewEquityFinancingEBIT $500,000 $150,000*Interest

0 0EBT $500,000 $150,000Taxes(30%xEBT) 150,000 45,000EAT $350,000 $105,000PreferredDividends

0 0EACS $350,000 $105,000#ofShares 100,000 100,000EPS $3.50 $1.05CommonStockEquityAlternative*Asecondanalysisusing$150,000EBITratherthantheexpectedEBIT.EBIT-EPSCalculationwithNewEBIT-EPSChart0100200300400500600700EBIT($thousands)EarningsperShare($)0123456CommonEBIT-EPSChart0100EBIT-EPSCalculationwithNewDebtFinancingEBIT $500,000 $150,000*Interest 100,000 100,000EBT $400,000 $50,000Taxes(30%xEBT) 120,000 15,000EAT $280,000 $35,000PreferredDividends

0 0EACS $280,000 $35,000#ofShares 50,000 50,000EPS $5.60 $0.70Long-termDebtAlternative*Asecondanalysisusing$150,000EBITratherthantheexpectedEBIT.EBIT-EPSCalculationwithNewEBIT-EPSChart0100200300400500600700EBIT($thousands)EarningsperShare($)0123456CommonDebtIndifferencepointbetweendebt

andcommonstockfinancingEBIT-EPSChart0100EBIT-EPSCalculationwithNewPreferredFinancingEBIT $500,000 $150,000*Interest

0 0EBT $500,000 $150,000Taxes(30%xEBT) 150,000 45,000EAT $350,000 $105,000PreferredDividends 90,000 90,000EACS $260,000 $15,000#ofShares 50,000 50,000EPS $5.20 $0.30PreferredStockAlternative*Asecondanalysisusing$150,000EBITratherthantheexpectedEBIT.EBIT-EPSCalculationwithNew0100200300400500600700EBIT-EPSChartEBIT($thousands)EarningsperShare($)0123456CommonDebtIndifferencepointbetweenpreferredstockand

commonstock

financingPreferred010020030WhatAboutRisk?0100200300400500600700EBIT($thousands)EarningsperShare($)0123456CommonDebtLowerrisk.OnlyasmallprobabilitythatEPSwillbelessifthedebtalternativeischosen.ProbabilityofOccurrence(fortheprobabilitydistribution)WhatAboutRisk?0100WhatAboutRisk?0100200300400500600700EBIT($thousands)EarningsperShare($)0123456CommonDebtHigherrisk.AmuchlargerprobabilitythatEPSwillbelessifthedebtalternativeischosen.ProbabilityofOccurrence(fortheprobabilitydistribution)WhatAboutRisk?0100DegreeofFinancialLeverage(DFL)DFLatEBITofXdollarsDegreeofFinancialLeverage--Thepercentagechangeinafirm’searningspershare(EPS)resultingfroma1percentchangeinoperatingprofit.=Percentagechangeinearningspershare(EPS)Percentagechangeinoperatingprofit(EBIT)DegreeofFinancialLeverage(ComputingtheDFLDFLEBITof$XCalculatingtheDFL=EBITEBIT-I-[PD/(1-t)]EBIT =EarningsbeforeinterestandtaxesI =InterestPD =Preferreddividendst =CorporatetaxrateComputingtheDFLDFLEBITof$WhatistheDFLforEachoftheFinancingChoices?DFL

$500,000CalculatingtheDFLforNEWequity*alternative=$500,000$500,000-0-[0/(1-0)]*ThecalculationisbasedontheexpectedEBIT=1.00WhatistheDFLforEachofthWhatistheDFLforEachoftheFinancingChoices?DFL

$500,000CalculatingtheDFLforNEWdebt*alternative=$500,000{$500,000-100,000-[0/(1-0)]}*ThecalculationisbasedontheexpectedEBIT=$500,000

/$400,0001.25=WhatistheDFLforEachofthWhatistheDFLforEachoftheFinancingChoices?DFL

$500,000CalculatingtheDFLforNEWpreferred*alternative=$500,000{$500,000-0-[90,000/(1-.30)]}*ThecalculationisbasedontheexpectedEBIT=$500,000

/$400,0001.35=WhatistheDFLforEachofthVariabilityofEPSPreferredstockfinancingwillleadtothegreatestvariabilityinearningspersharebasedontheDFL.Thisisduetothetaxdeductibilityofinterestondebtfinancing.DFLEquity =1.00DFLDebt =1.25DFLPreferred=

1.35WhichfinancingmethodwillhavethegreatestrelativevariabilityinEPS?VariabilityofEPSPreferredstFinancialRiskDebtincreasestheprobabilityofcashinsolvencyoveranall-equity-financedfirm.Forexample,ourexamplefirmmusthaveEBITofatleast$100,000tocovertheinterestpayment.DebtalsoincreasedthevariabilityinEPSastheDFLincreasedfrom1.00to1.25.FinancialRisk--Theaddedvariabilityinearningspershare(EPS)--plustheriskofpossibleinsolvency--thatisinducedbytheuseoffinancialleverage.FinancialRiskDebtincreasestTotalFirmRiskCVEPSisameasureofrelativetotalfirmriskCVEBITisameasureofrelativebusinessriskThedifference,CVEPS-CVEBIT,isameasureofrelativefinancialriskTotalFirmRisk--Thevariabilityinearningspershare(EPS).Itisthesumofbusinessplusfinancialrisk.Totalfirmrisk=businessrisk+financialriskTotalFirmRiskCVEPSisameasDegreeofTotalLeverage(DTL)DTLatQunits(orSdollars)ofoutput(orsales)DegreeofTotalLeverage--Thepercentagechangeinafirm’searningspershare(EPS)resultingfroma1percentchangeinoutput(sales).=Percentagechangeinearningspershare(EPS)Percentagechangeinoutput(orsales)DegreeofTotalLeverage(DTL)ComputingtheDTLDTLSdollars ofsalesDTLQunits(orSdollars)=(DOLQunits(orSdollars))

x(DFLEBITofXdollars)=EBIT+FCEBIT-I-[PD/(1-t)]DTLQunitsQ(P

-V)Q(P

-V)-FC-I-[PD/(1-t)]=ComputingtheDTLDTLSdollarsDTLExample

LisaMillerwantstodeterminetheDegreeofTotalLeverageatEBIT=$500,000.Aswedidearlier,wewillassumethat:Fixedcostsare$100,000Basketsaresoldfor$43.75

eachVariablecostsare$18.75perbasketDTLExample LisaMillerwantsComputingtheDTL forAll-EquityFinancingDTLSdollars ofsales=$500,000+$100,000$500,000-0-[0/(1-.3)]DTLSdollars=(DOLSdollars)x(DFLEBITof$S)DTLSdollars=(1.2)x(1.0*

)=1.20=1.20*Note:Nofinancialleverage.ComputingtheDTL forAll-EqComputingtheDTL forDebtFinancingDTLSdollars ofsales=$500,000+$100,000{$500,000-$100,000

-[0/(1-.3)]}DTLSdollars=(DOLSdollars)x(DFLEBITof$S)DTLSdollars=(1.2)x(1.25*

)=1.50=1.50*Note:CalculatedonSlide39.ComputingtheDTL forDebtFRiskversusReturnComparetheexpectedEPStotheDTLforthecommonstockequityfinancingapproachtothedebtfinancingapproach.

Financing

E(EPS) DTLEquity $3.50 1.20Debt $5.60 1.50Greaterexpectedreturn(higherEPS)comesattheexpenseofgreaterpotentialrisk(higherDTL)!RiskversusReturnComparetheWhatisanAppropriate AmountofFinancialLeverage?Firmsmustfirstanalyzetheirexpectedfuturecashflows.Thegreaterandmorestabletheexpectedfuturecashflows,thegreaterthedebtcapacity.Fixedchargesinclude:debtprincipalandinterestpayments,leasepayments,andpreferredstockdividends.DebtCapacity--Themaximumamountofdebt(andotherfixed-chargefinancing)thatafirmcanadequatelyservice.WhatisanAppropriate AmountCoverageRatiosInterestCoverageEBITInterestexpensesIndicatesafirm’sabilitytocoverinterestcharges.IncomeStatementRatiosCoverageRatiosAratiovalueequalto1indicatesthatearningsarejustsufficienttocoverinterestcharges.CoverageRatiosInterestCoveraCoverageRatiosDebt-serviceCoverageEBIT{Interestexpenses+[Principalpayments/(1-t)]}Indicatesafirm’sabilitytocoverinterestexpensesandprincipalpayments.IncomeStatementRatiosCoverageRatiosAllowsustoexaminetheabilityofthefirmtomeetallofitsdebtpayments.Failuretomakeprincipalpaymentsisalsodefault.CoverageRatiosDebt-serviceCoCoverageExampleMakeanexaminationofthecoverageratiosforBasketWonderswhenEBIT=$500,000.Comparetheequityandthedebtfinancingalternatives.Assumethat:Interestexpensesremainat$100,000Principalpaymentsof$100,000aremadeyearlyfor10yearsCoverageExampleMakeanexaminCoverageExampleComparetheinterestcoverageanddebtburdenratiosforequityanddebtfinancing. Interest Debt-service

Financing

Coverage CoverageEquity Infinite InfiniteDebt 5.00 2.50Thefirmactuallyhasgreaterriskthantheinterestcoverageratioinitiallysuggests.CoverageExampleComparetheinCoverageExample-25002505007501,0001,250EBIT($thousands)FirmBhasamuchsmallerprobabilityoffailingtomeetitsobligationsthanFirmA.FirmBFirmADebt-serviceburden=$200,000PROBABILITYOFOCCURRENCECoverageExample-2500SummaryoftheCoverageRatioDiscussionAsingleratiovaluecannotbeinterpretedidenticallyforallfirmsassomefirmshavegreaterdebtcapacity.Annualfinancialleasepaymentsshouldbeaddedtoboththenumeratoranddenominatorofthedebt-servicecoverageratioasfinancialleasesaresimilartodebt.Thedebt-servicecoverageratioaccountsforrequiredannualprincipalpayments.SummaryoftheCoverageRatioOtherMethodsofAnalysisOften,firmsarecomparedtopeerinstitutionsinthesameindustry.Largedeviationsfromnormsmustbejustified.Forexample,anindustry’smediandebt-to-net-worthratiomightbeusedasabenchmarkforfinancialleveragecomparisons.CapitalStructure--Themix(orproportion)ofafirm抯permanentlong-termfinancingrepresentedbydebt,preferredstock,andcommonstockequity.OtherMethodsofAnalysisOftenOtherMethodsofAnalysisFirmsmaygaininsightintothefinancialmarkets’evaluationoftheirfirmbytalkingwith:InvestmentbankersInstitutionalinvestorsInvestmentanalystsLendersSurveyingInvestmentAnalystsandLendersOtherMethodsofAnalysisFirmsOtherMethodsofAnalysisFirmsmustconsidertheimpactofanyfinancingdecisiononthefirm’ssecurityrating(s).SecurityRatingsOtherMethodsofAnalysisFirmsChapter16OperatingandFinancialLeverageChapter16OperatingandFinancOperatingandFinancialLeverageOperatingLeverageFinancialLeverageTotalLeverageCash-FlowAbilitytoServiceDebtOtherMethodsofAnalysisCombinationofMethodsOperatingandFinancialLeveraOperatingLeverageOnepotentialeffectcausedbythepresenceofoperatingleverageisthatachangeinthevolumeofsalesresultsinamorethanproportionalchangeinoperatingprofit(orloss).OperatingLeverage--Theuseoffixedoperatingcostsbythefirm.OperatingLeverageOnepotentiaImpactofOperatingLeverageonProfits

FirmFFirmVFirm2FSales $10 $11 $19.5OperatingCosts Fixed 7 2 14Variable 2 7 3OperatingProfit

$

1 $2 $2.5 FC/totalcosts .78 .22 .82FC/sales .70 .18 .72(inthousands)ImpactofOperatingLeverageoImpactofOperatingLeverageonProfitsNow,subjecteachfirmtoa50%increaseinsalesfornextyear.WhichfirmdoyouthinkwillbemoreSensitivetothechangeinsales(i.e.,showthelargestpercentagechangeinoperatingprofit,EBIT)?[]FirmF;[]FirmV;[]Firm2F.ImpactofOperatingLeverageoImpactofOperatingLeverageonProfits

FirmFFirmVFirm2FSales $15 $16.5 $29.25OperatingCosts

Fixed 7 2 14Variable 3 10.5 4.5OperatingProfit

$

5 $4 $10.75Percentage ChangeinEBIT* 400%100%330%(inthousands)*(EBITt-EBITt-1)/EBITt-1ImpactofOperatingLeverageoImpactofOperatingLeverageonProfitsFirmFisthemostSensitivefirm--forit,a50%increaseinsalesleadstoa400%increaseinEBIT.Ourexamplerevealsthatitisamistaketoassumethatthefirmwiththelargestabsoluteorrelativeamountoffixedcostsautomaticallyshowsthemostdramaticeffectsofoperatingleverage.Later,wewillcomeupwithaneasywaytospotthefirmthatismostsensitivetothepresenceofoperatingleverage.ImpactofOperatingLeverageoBreak-EvenAnalysisWhenstudyingoperatingleverage,profitsreferstooperatingprofitsbeforetaxes(i.e.,EBIT)andexcludesdebtinterestanddividendpayments.Break-EvenAnalysis--Atechniqueforstudyingtherelationshipamongfixedcosts,variablecosts,profits,andsalesvolume.Break-EvenAnalysisWhenstudyiBreak-EvenChartQUANTITYPRODUCEDANDSOLD01,0002,0003,0004,0005,0006,0007,000TotalRevenuesProfitsFixedCostsVariableCostsLossesREVENUESANDCOSTS($thousandsotalCostsBreak-EvenChartQUANTITYPRODUBreak-Even(Quantity)Point

Howtofindthequantitybreak-evenpoint: EBIT=P(Q)-V(Q)-FC EBIT=Q(P-V)-FCP=Priceperunit

V=VariablecostsperunitFC=Fixedcosts Q=Quantity(units) producedandsoldBreak-EvenPoint--Thesalesvolumerequiredsothattotalrevenuesandtotalcostsareequal;maybeinunitsorinsalesdollars.Break-Even(Quantity)Point HoBreak-Even(Quantity)PointBreak-evenoccurswhenEBIT=0

Q(P-V)-FC =EBIT

QBE(P-V)-FC =0

QBE(P-V) =FC

QBE =FC

/(P-V)Break-Even(Quantity)PointBreBreak-Even(Sales)PointHowtofindthesalesbreak-evenpoint:

SBE

=

FC+(VCBE)

SBE

=

FC+(QBE)(V)

or

SBE* =

FC/[1-(VC/S)]*RefertotextforderivationoftheformulaBreak-Even(Sales)PointHowtoBreak-EvenPointExample

BasketWonders(BW)wantstodetermineboththequantityandsalesbreak-evenpointswhen:Fixedcostsare$100,000Basketsaresoldfor$43.75

eachVariablecostsare$18.75perbasketBreak-EvenPointExample BaskeBreak-EvenPoint(s)Break-evenoccurswhen:

QBE =FC

/(P-V)

QBE =$100,000

/($43.75-$18.75)

QBE =4,000Units SBE

=

(QBE)(V)+FC SBE

=

(4,000)($18.75)+$100,000

SBE =$175,000Break-EvenPoint(s)Break-evenBreak-EvenChartQUANTITYPRODUCEDANDSOLD01,0002,0003,0004,0005,0006,0007,000TotalRevenuesProfitsFixedCostsVariableCostsLossesREVENUESANDCOSTS($thousandsotalCostsBreak-EvenChartQUANTITYPRODUDegreeofOperatingLeverage(DOL)DOLatQunitsofoutput(orsales)DegreeofOperatingLeverage--Thepercentagechangeinafirm’soperatingprofit(EBIT)resultingfroma1percentchangeinoutput(sales).=Percentagechangeinoperatingprofit(EBIT)Percentagechangeinoutput(orsales)DegreeofOperatingLeverage(ComputingtheDOLDOLQunitsCalculatingtheDOLforasingleproductorasingle-productfirm.=Q(P-V)Q(P-V)-FC=QQ-QBEComputingtheDOLDOLQunitsCalComputingtheDOLDOLSdollarsofsalesCalculatingtheDOLforamultiproductfirm.=S-VCS-VC-FC=EBIT+FCEBITComputingtheDOLDOLSdollarsBreak-EvenPointExample

LisaMillerwantstodeterminethedegreeofoperatingleverageatsaleslevelsof6,000and8,000units.Aswedidearlier,wewillassumethat:Fixedcostsare$100,000Basketsaresoldfor$43.75

eachVariablecostsare$18.75perbasketBreak-EvenPointExample LisaComputingBW’sDOLDOL6,000unitsComputationbasedonthepreviouslycalculatedbreak-evenpointof4,000units=6,0006,000-4,000==3DOL8,000units8,0008,000-4,000=2ComputingBW’sDOLDOL6,000uniInterpretationoftheDOLA1%increaseinsalesabovethe8,000unitlevelincreasesEBITby2%becauseoftheexistingoperatingleverageofthefirm.=DOL8,000units8,0008,000-4,000=2InterpretationoftheDOLA1%InterpretationoftheDOL2,0004,0006,0008,00012345QUANTITYPRODUCEDANDSOLD0-1-2-3-4-5DEGREEOFOPERATINGLEVERAGE(DOL)QBEInterpretationoftheDOL2,000InterpretationoftheDOLDOLisaquantitativemeasureofthesensitivityofafirm’soperatingprofittoachangeinthefirm’ssales.Thecloserthatafirmoperatestoitsbreak-evenpoint,thehigheristheabsolutevalueofitsDOL.Whencomparingfirms,thefirmwiththehighestDOListhefirmthatwillbemostsensitivetoachangeinsales.KeyConclusionstobeDrawnfromslide16-22andourDiscussionofDOLInterpretationoftheDOLDOLiDOLandBusinessRiskDOLisonlyonecomponentofbusinessriskandbecomesactiveonlyinthepresenceofsalesandproductioncostvariability.DOLmagnifiesthevariabilityofoperatingprofitsand,hence,businessrisk.BusinessRisk--Theinherentuncertaintyinthephysicaloperationsofthefirm.Itsimpactisshowninthevariabilityofthefirm’soperatingincome(EBIT).DOLandBusinessRiskDOLisonFinancialLeverageFinancialleverageisacquiredbychoice.Usedasameansofincreasingthereturntocommonshareholders.FinancialLeverage--Theuseoffixedfinancingcostsbythefirm.TheBritishexpressionisgearing.FinancialLeverageFinancialleEBIT-EPSBreak-Even,orIndifference,AnalysisCalculateEPSforagivenlevelofEBITatagivenfinancingstructure.EBIT-EPSBreak-EvenAnalysis--Analysisoftheeffectoffinancingalternativesonearningspershare.Thebreak-evenpointistheEBITlevelwhereEPSisthesamefortwo(ormore)alternatives.(EBIT-I)(1-t)-Pref.Div.#ofCommonSharesEPS=EBIT-EPSBreak-Even,orIndiffEBIT-EPSChartCurrentcommonequityshares=50,000$1millioninnewfinancingofeither:AllC.S.soldat$20/share(50,000shares)Alldebtwithacouponrateof10%AllP.S.withadividendrateof9%ExpectedEBIT=$500,000Incometaxrateis30%BasketWondershas$2millioninLTfinancing(100%commonstockequity).EBIT-EPSChartCurrentcommoneEBIT-EPSCalculationwithNewEquityFinancingEBIT