1、16-116-2uOperating LeverageuFinancial LeverageuTotal LeverageuCash-Flow Ability to Service DebtuOther Methods of AnalysisuCombination of Methods16-3uOne potential effect caused by the presence of operating leverage is that a change in the volume of sales results in a more than proportional change in
2、 operating profit(or loss).16-4 Sales$10$11$19.5Operating CostsFixed 7 2 14 Variable 2 7 3Operating Profit FC/total costs.78.22 .82 FC/sales.70.18 .7216-5uNow,subject each firm to a for next year.uWhich firm do you think will be more to the change in sales(i.e.,show the largest percentage change in
3、operating profit,EBIT)?;.16-6 Sales$15$16.5$29.25Operating Costs Fixed 7 2 14 Variable 310.5 4.5Operating Profit *(EBITt-EBIT t-1)/EBIT t-116-7-for it,a 50%increase in sales leads to a.uOur example reveals that it is a mistake to assume that the firm with the largest absolute or relative amount of f
4、ixed costs automatically shows the most dramatic effects of operating leverage.uLater,we will come up with an easy way to spot the firm that is most sensitive to the presence of operating leverage.16-8uWhen studying operating leverage,profits refers to operating profits before taxes(i.e.,EBIT)and ex
5、cludes debt interest and dividend payments.-A technique for studying the relationship among fixed costs,variable costs,and sales volume.16-90 1,000 2,000 3,000 5,000 6,000 7,000250100 5016-10How to find the quantity break-even point:EBIT=()-()-EBIT=(-)-16-11Break-even occurs when EBIT=0(-)-=EBIT(-)-
6、=0(-)=/(-)16-12How to find the sales break-even point:=+()=+()()or=/1-(/S)*Refer to text for derivation of the formula16-13Basket Wonders(BW)wants to determine both the when:are uBaskets are sold for uVariable costs are 16-14Break-even occurs when:=/(-)=/(-)=()()+=()()+=16-150 1,000 2,000 3,000 5,00
7、0 6,000 7,000250100 5016-16 at Q units of output(or sales)-The percentage change in a firms operating profit(EBIT)resulting from a 1 percent change in output(sales).=Percentage change in operating profit(EBIT)Percentage change in output(or sales)16-17=(-)(-)-=-16-18=-=EBIT+EBIT16-19Lisa Miller wants
8、 to determine the at.As we did earlier,we will assume that:are uBaskets are sold for uVariable costs are 16-20=-=-=16-21=-=16-2216-23uDOL is a quantitative measure of the sensitivity of a firms operating profit to a change in the firms sales.uThe closer that a firm operates to its break-even point,t
9、he higher is the absolute value of its DOL.uWhen comparing firms,the firm with the highest DOL is the firm that will be most sensitive to a change in sales.16-24uDOL is only of business risk and becomes active.uDOL the variability of operating profits and,hence,business risk.16-25uFinancial leverage
10、 is acquired by choice.uUsed as a means of increasing the return to common shareholders.16-26Calculate for a given level of at a given financing structure.(-I)(1-t)-Pref.Div.#of Common Shares=16-27uAll C.S.sold at$20/share(50,000 shares)uAll debt with a coupon rate of 10%uAll P.S.with a dividend rat
11、e of 9%16-28*Interest 0 0EBT$500,000$150,000Taxes(30%x EBT)150,000 45,000EAT$350,000$105,000Preferred Dividends 0 0#of Shares 100,000 100,000*A second analysis using$150,000 EBIT rather than the expected EBIT.16-2916-30*Interest 100,000 100,000EBT$400,000$50,000Taxes(30%x EBT)120,000 15,000EAT$280,0
12、00$35,000Preferred Dividends 0 0#of Shares 50,000 50,000*A second analysis using$150,000 EBIT rather than the expected EBIT.16-31Indifference pointbetween andfinancing16-32*Interest 0 0EBT$500,000$150,000Taxes(30%x EBT)150,000 45,000EAT$350,000$105,000Preferred Dividends 90,000 90,000#of Shares 50,0
13、00 50,000*A second analysis using$150,000 EBIT rather than the expected EBIT.16-33Indifference pointbetween andfinancing16-34.Only a smallprobability that EPS willbe less if the debtalternative is chosen.16-35.A much largerprobability that EPS willbe less if the debtalternative is chosen.16-36 at EB
14、IT of X dollars-The percentage change in a firms earnings per share(EPS)resulting from a 1 percent change in operating profit.=Percentage change in earnings per share(EPS)Percentage change in operating profit(EBIT)16-37 EBIT of$X=-/(1-)16-38*=-/(1-)*The calculation is based on the expected EBIT=16-3
15、9*=-/(1-)*The calculation is based on the expected EBIT=/$400,000=16-40*=-/(1-)*The calculation is based on the expected EBIT=/$400,000=16-41financing will lead to the greatest variability in earnings per share based on the DFL.uThis is due to the tax deductibility of interest on debt financing.Whic
16、h financing method will have the 16-42uDebt increases the probability of cash insolvency over an all-equity-financed firm.For example,our example firm must have EBIT of at least$100,000 to cover the interest payment.uDebt also increased the variability in EPS as the DFL increased from 1.00 to 1.25.1
17、6-43 is a measure of relative is a measure of relative uThe difference,is a measure of relative=+16-44 at Q units(or S dollars)of output(or sales)-The percentage change in a firms earnings per share(EPS)resulting from a 1 percent change in output(sales).=Percentage change in earnings per share(EPS)P
18、ercentage change in output(or sales)16-45 S dollarsof sales=()x()=+FC-/(1-)Q units()()-FC-/(1-)=16-46Lisa Miller wants to determine the at As we did earlier,we will assume that:are uBaskets are sold for uVariable costs are 16-47 S dollarsof sales=+$100,000-/(1-)=()x()=()x(*)=*Note:No financial lever
19、age.16-48 S dollarsof sales=+$100,000-/(1-)=()x()=()x(*)=*Note:Calculated on Slide 39.16-49Compare the expected EPS to the DTL for the common stock equity financing approach to the debt financing approach.16-50uFirms must first analyze their uThe and the expected future cash flows,:debt principal an
20、d interest payments,lease payments,and preferred stock dividends.16-51Indicates a firms ability to cover interest charges.Income StatementRatiosCoverage RatiosA ratio value equal to 1indicates that earningsare just sufficient tocover interest charges.16-52 +Indicates a firms ability to cover interes
21、t expenses and principal payments.Income StatementRatiosCoverage RatiosAllows us to examine theability of the firm to meetall of its debt payments.Failure to make principalpayments is also default.16-53Make an examination of the for Basket Wonders when Compare the equity and the debt financing alter
22、natives.Assume that:remain at are made yearly for 10 years16-54Compare the interest coverage and debt burden ratios for equity and debt financing.16-55Firm B has a much smaller probabilityof failing to meet its obligations than Firm A.16-56uA single ratio value cannot be interpreted identically for
23、all firms as some firms have greater debt capacity.uAnnual financial lease payments should be added to both the numerator and denominator of the debt-service coverage ratio as financial leases are similar to debt.uThe debt-service coverage ratio accounts for required annual principal payments.16-57u
24、Often,firms are compared to peer institutions in the same industry.uLarge deviations from norms must be justified.uFor example,an industrys median debt-to-net-worth ratio might be used as a benchmark for financial leverage comparisons.16-58uFirms may gain insight into the financial markets evaluation of their firm by talking with:uInvestment bankersuInstitutional investorsuInvestment analystsuLenders16-59uFirms must consider the impact of any financing decision on the firms security rating(s).
