Asked by Nathan Tsung on May 30, 2024
Verified
Suppose a firm increases the operating leverage used to produce a given quantity of output.What will this normally lead to?
A) a decrease in the standard deviation of its expected EBIT
B) a decrease in its business risk
C) a decrease in the variability of its expected EPS
D) a reduction in its fixed assets turnover ratio
Operating Leverage
A measure of how much a company can increase its operating income by increasing revenue, indicating the ratio of fixed costs to variable costs.
EBIT
Earnings Before Interest and Taxes; a measure of a company's profitability that focuses on earnings generated from its core operations before the impact of financial and tax activities.
Business Risk
The exposure a company or investor faces due to uncertainties in the market or industry that could affect its profitability.
- Analyze the impact of operating leverage on a firm's earnings and risk.
Verified Answer
GT
Gianni ToribioJun 01, 2024
Final Answer :
D
Explanation :
Increasing operating leverage typically involves increasing fixed costs relative to variable costs. This does not decrease the standard deviation of expected EBIT, decrease business risk, or decrease the variability of expected EPS. Instead, it often leads to a reduction in the fixed assets turnover ratio because the firm is utilizing more fixed assets (increasing fixed costs) relative to its sales.
Learning Objectives
- Analyze the impact of operating leverage on a firm's earnings and risk.