Understanding Leverage Concepts

What is financial leverage?

• Using personal savings to fund investments

• Investing only in cash without any loans

• Financial leverage is the use of borrowed capital to increase the potential return on investment.

• A method to reduce overall investment risk

How does financial leverage affect a company's return on equity?

• Financial leverage can increase a company's return on equity by amplifying profits, but it also increases financial risk.

• Financial leverage has no impact on return on equity.

• Financial leverage only affects a company's debt levels.

• Higher financial leverage always reduces profits.

What are the advantages of using financial leverage?

• Lower interest rates on loans

• Increased potential returns, tax benefits, and enhanced investment capacity.

• Guaranteed profits on investments

• Reduced risk of loss

What are the disadvantages of financial leverage?

• Increased market share

• Improved cash flow management

• Disadvantages of financial leverage include increased risk of loss, higher interest costs, potential cash flow problems, and risk of bankruptcy.

• Lower operational costs

Define operating leverage.

• Operating leverage is the ability to reduce fixed costs in a business.

• Operating leverage is the degree to which a company can increase its profits by increasing sales, due to fixed costs in its cost structure.

• Operating leverage measures the efficiency of a company's workforce.

• Operating leverage refers to the total amount of variable costs a company incurs.

How is operating leverage calculated?

• Operating leverage = % Change in EBIT / % Change in Sales

• Operating leverage = % Change in Net Income / % Change in Expenses

• Operating leverage = Sales / % Change in EBIT

• Operating leverage = EBIT / Total Assets

What is the significance of the degree of operating leverage?

• It measures the total revenue generated by a company.

• The degree of operating leverage indicates how sensitive operating income is to changes in sales volume.

• It reflects the overall profitability of a company.

• It indicates the level of fixed costs in a business.

How does operating leverage impact a company's profitability?

• Operating leverage has no effect on a company's profitability regardless of sales changes.

• Operating leverage can amplify a company's profitability by increasing the impact of sales changes on profits.

• Operating leverage only affects a company's revenue, not its profitability.

• Operating leverage decreases a company's profitability by reducing the impact of sales changes on profits.

What is the relationship between fixed costs and operating leverage?

• Lower fixed costs increase operating leverage.

• Higher fixed costs increase operating leverage.

• Higher variable costs decrease operating leverage.

• Operating leverage is unrelated to fixed costs.

What is risk in the context of leverage?

• Risk refers to the safety of using borrowed funds in investments.

• Risk is the potential for profit from borrowed funds.

• Risk in the context of leverage refers to the increased potential for loss due to amplified exposure from borrowed funds.

• Risk in leverage is the guarantee of returns on investments.