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Sld05 Operating and Fin Leverage
Sld05 Operating and Fin Leverage
FIVE
Operating and
Financial Leverage
McGraw-Hill Ryerson
FIF T H
Foundations of Financial
Management
th
CANADIAN
PPT 5-1
EDI TI ON
Figure 5-1
Break-even chart: Leveraged firm
Total
Revenue
160
120
100
80
60
40
BE
Variable costs
Loss
20
Block
Hirt
Short
Total
costs
Fixed
costs
40
50
60
80
100
120
FIF T H
Foundations of Financial
Management
th
CANADIAN
PPT 5-2
EDI TI ON
Table 5-2
Volume-cost-profit analysis: Leveraged firm
Units
Sold
Total
Variable
Costs
0
0
20,000 $16,000
40,000 32,000
50,000 40,000
60,000 48,000
80,000 64,000
100,000 80,000
Fixed
Costs
$ 60,000
60,000
60,000
60,000
60,000
60,000
60,000
Total
Costs
$ 60,000
76,000
92,000
100,000
108,000
124,000
140,000
Total
Revenue
0
$ 40,000
80,000
100,000
120,000
160,000
200,000
Operating
Income
(loss)
$ (60,000)
(36,000)
(12,000)
0
12,000
36,000
60,000
Block
Hirt
Short
McGraw-Hill Ryerson
FIF T H
Foundations of Financial
Management
th
CANADIAN
PPT 5-3
EDI TI ON
Figure 5-2
Break-even chart: Conservative firm
Total
Revenue
Profit
Total
costs
160
120
80
40
BE
20
Loss
Block
Hirt
Short
Variable costs
40
60
80
100
120
Fixed
costs
FIF T H
Foundations of Financial
Management
th
CANADIAN
PPT 5-4
EDI TI ON
Table 5-3
Volume-cost-profit analysis: Conservative firm
Units
Sold
0
20,000
30,000
40,000
60,000
80,000
100,000
Total
Variable
Costs
0
$ 32,000
48,000
64,000
96,000
128,000
160,000
Fixed
Costs
Total
Costs
$ 12,000
$12,000
12,000
12,000
12,000
12,000
12,000
12,000
44,000
60,000
76,000
108,000
140,000
172,000
Operating
Total
Income
Revenue
(loss)
0
$ 40,000
60,000
80,000
120,000
160,000
200,000
$ (12,000)
(4,000)
0
4,000
12,000
20,000
28,000
.
Block
Hirt
Short
McGraw-Hill Ryerson
FIF T H
Foundations of Financial
Management
th
CANADIAN
PPT 5-5
EDI TI ON
Table 5-4
Operating income or loss
Leveraged
Firm
(Table 5-2)
Units
0
20,000
40,000
60,000
80,000
100,000
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
.
$(60,000)
(36,000)
(12,000)
12,000
36,000
60,000
Conservative
Firm
(Table 5-3)
$(12,000)
(4,000)
4,000
12,000
20,000
28,000
Block
Hirt
Short
McGraw-Hill Ryerson
FIF T H
Foundations of Financial
Management
th
CANADIAN
PPT 5-6
EDI TI ON
Figure 5-3
Nonlinear break-even analysis
Revenue
weakness
160
Total
revenue
Cost
overruns
120
80
Total
costs
40
120
Block
Hirt
Short
20
40 area 60
Valid
80
100
Units (thousands)
McGraw-Hill Ryerson
FIF T H
th
CANADIAN
Foundations of Financial
Management
EDI TI ON
Table 5-5a
Impact of financing plan on earnings per share
Plan A
(leveraged)
Block
Hirt
Short
PPT 5-7
1. EBIT (0)
Earnings before interest and taxes (EBIT)
Interest (I)
Earnings before taxes (EBT)
Taxes (T) *
Earnings aftertaxes(EAT)
Shares
Earnings per share (EPS)
2. EBIT ($12,000)
Earnings before interest and taxes (EBIT)
Interest (I)
Earnings before taxes (EBT)
Taxes (T)
Earnings aftertaxes (EAT)
Shares
Earnings per share (EPS)
Plan B
(conservative)
0
$(12,000)
(12,000)
(6,000)
$ (6,000)
8,000
$ (0.75)
$ (4,000)
(4,000)
(2,000)
$ (2,000)
24,000
$ (0.08)
$12,000
12,000
0
0
$
0
8,000
0
$12,000
4,000
8,000
4,000
$ 4,000
24,000
$0.17
0
.
* The assumption is that large losses can be written off against other income, perhaps in other years,
thus providing the firm with a tax savings benefit. The tax rate is 50 percent for ease of computation.
McGraw-Hill Ryerson Limited 2000
McGraw-Hill Ryerson
FIF T H
Block
Hirt
Short
th
CANADIAN
Foundations of Financial
Management
PPT 5-7
EDI TI ON
Table 5-5b
Impact of financing plan on earnings per share
Plan A
(leveraged)
Plan B
(conservative)
3. EBIT ($16,000)
Earnings before interest and taxes (EBIT)
Interest (I)
Earnings before taxes (EBT)
Taxes (T)
Earnings aftertaxes (EAT)
Shares
Earnings per share (EPS)
$ 16,000
12,000
4,000
2,000
$ 2,000
8,000
$0.25
$ 16,000
4,000
12,000
6,000
$ 6,000
24,000
$0.25
4. EBIT ($36,000)
Earnings before interest and taxes (EBIT)
Interest (I)
Earnings before taxes (EBT)
Taxes (T)
Earnings aftertaxes (EAT)
Shares
Earnings per share (EPS)
$ 36,000
12,000
24,000
12,000
$ 12,000
8,000
$1.50
$ 36,000
4,000
32,000
16,000
$ 16,000
24,000
$0.67
McGraw-Hill Ryerson
FIF T H
th
CANADIAN
Foundations of Financial
Management
PPT 5-7
EDI TI ON
Table 5-5c
Impact of financing plan on earnings per share
5. EBIT ($60,000)
Earnings before interest and taxes (EBIT)
Interest (I)
Earnings before taxes (EBT)
Taxes (T)
Earnings aftertaxes (EAT)
Shares
Earnings per share (EPS)
Plan A
(leveraged)
Plan B
(conservative)
$ 60,000
12,000
48,000
24,000
$ 24,000
8,000
$3.00
$ 60,000
4,000
56,000
28,000
$ 28,000
24,000
$ 1.17
Block
Hirt
Short
McGraw-Hill Ryerson
FIF T H
Foundations of Financial
Management
th
CANADIAN
PPT 5-8
EDI TI ON
Figure 5-4
Financing plans and earnings per share
EPS ($)
4
Plan A
3
2
Plan B
1
.25
0
-1
Block
Hirt
Short
-2
0
McGraw-Hill Ryerson
12
16
25
50
75
EBIT ($ thousands)
100
McGraw-Hill Ryerson Limited 2000
FIF T H
Foundations of Financial
Management
th
CANADIAN
PPT 5-9
EDI TI ON
Figure 5-5
Financial leverage in selected industries (third quarter, 1998)
Total debt / equity
8.00
7.00
Ratio
6.00
5.00
4.00
3.00
2.00
Tele communications
Re al estate
Electronics,
computers
Motor vehicles
Machinery,
equipment
Chemical, te xtile s
Wood, paper
Food
Block
Hirt
Short
All nonfinancial
0.00
All industries
1.00
Source : Sta tistics Ca na da , Quarte rly Financia l S ta tistics for Ente rprise s, Ca talogue 61-008
XPB, third qua rte r, 1998.
McGraw-Hill Ryerson
FIF T H
th
CANADIAN
EDI TI ON
Table 5-6
Income statement
Sales (total revenue) (80,000 units @ $2)
Fixed costs
Variable costs ($0.80 per unit)
Operating income
Earnings before interest and taxes
Interest
Earnings before taxes
Taxes
Earnings aftertaxes
Shares
Earnings per share
$160,000
60,000
64,000
$ 36,000
$ 36,000
12,000
24,000
12,000
$ 12,000
8,000
$1.50
Operating
leverage
Financial
leverage
Block
Hirt
Short
McGraw-Hill Ryerson
FIF T H
th
CANADIAN
EDI TI ON
Figure 5-6
Combining operating and financial leverage
$
Earnings generated
EPS =
$1.50
Financial
leverage
$36,000
Operating
leverage
Block
Hirt
Short
Sales =
$160,000
Leverage impact
McGraw-Hill Ryerson
FIF T H
th
CANADIAN
EDI TI ON
Table 5-7
Operating and financial leverage
(Taken from Table 5-6)
(80,000 units)
Sales $2 per unit
Fixed costs
Variable costs ($0.80 per unit)
Operating income (EBIT)
Interest
Earnings before taxes
Taxes
Earnings aftertaxes
Shares
Earnings per share
$160,000
60,000
64,000
36,000
12,000
24,000
12,000
$ 12,000
8,000
$1.50
(100,000 units)
$200,000
60,000
80,000
60,000
12,000
48,000
24,000
$ 24,000
8,000
$3.00
Block
Hirt
Short
McGraw-Hill Ryerson
FIF T H
th
CANADIAN
Foundations of Financial
Management
EDI TI ON
Chapter 5 - Outline
LT 5-1
What is Leverage?
Operating Leverage
Financial Leverage
Leverage Means Risk
Block
Hirt
Short
FIF T H
th
CANADIAN
Foundations of Financial
Management
EDI TI ON
What is Leverage?
LT 5-2
FIF T H
th
CANADIAN
Foundations of Financial
Management
EDI TI ON
Operating Leverage
LT 5-3
Block
Hirt
Short
FIF T H
th
CANADIAN
Foundations of Financial
Management
EDI TI ON
Financial Leverage
LT 5-4
Block
Hirt
Short
FIF T H
th
CANADIAN
Foundations of Financial
Management
EDI TI ON
LT 5-5
FIF T H
th
CANADIAN
Foundations of Financial
Management
EDI TI ON
LT 5-6