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1. Introduction to Leverage
   1. What is leverage? In business, leverage refers to ________(Critical Concept). Firms that have high fixed costs, such as interest expenses or plant and equipment, tend to have higher returns but with more risk. In a good economic climate, such firms prosper. In a poor economic climate, the opposite is true. There are three types of leverage used by business firms. They are operating leverage, financial leverage and combined leverage. See Slide What is Leverage? (40.0K)
   2. What is operating leverage? If you go in to business for yourself, one of your first decisions is to determine the level of fixed costs or plant and equipment that you will use in producing your product or service. If your sales are high and you have high fixed costs, your firm will do well. But, if your sales are low, you won't be able to meet your fixed costs. ____ is the extent to which fixed assets, like plant and equipment, and their associated fixed costs are used in a business(Key Term). See Slide Operating Leverage (54.0K)
   3. What is financial leverage? A second decision you will face if you go in to business is how you will finance your operations. Will you borrow money? The more you use borrowed money, or debt, the greater your return because you won't be giving up control of your firm to other owners. But, the more debt you have, the more risk you have. ____ is the extent to which debt financing is used in a business(Key Term). See Slide Financial Leverage (53.0K)
   4. What is combined leverage?Combined leverage is the extent to which both ____ and ____ is used in a business(Critical Concept). It is the combined effect of these two variables. See Slide Combined or Total Leverage (48.0K)
2. Breakeven Analysis
   1. Use of Fixed Assets. In order to evaluate the effect of fixed assets, like plant and equipment, on the firm, we must use breakeven analysis. ____ looks at the effect of both fixed and variable costs on the firm(Key Term).
   2. Operational Costs. Business firms incur three types of costs: ____, ____ and ____(Critical Concept). Fixed costs are those that do not change with sales. Examples are rent and property taxes. Variable costs change with sales and are usually defined as cost of goods sold. Semi-variable costs have both a fixed and variable component. For the purposes of breakeven analysis, variable costs and semi-variable costs are lumped together. See Slide Break-Even Point (43.0K) .
   3. Breakeven is the point at which revenue exactly covers expenses. This is the breakeven point at which profit is zero. The breakeven formula can be calculated in units or dollars to breakeven(Critical Concept). Breakeven will be higher with firms that have greater leverage. Take a look at a web-based example of breakeven analysis.Breakeven relationships. If fixed costs rise, breakeven point will rise. If variable costs rise, breakeven point will rise. If price rises, breakeven point will fall. Try using an interactive web-based calculator for a sample breakeven analysis.
   4. Cash Breakeven Point. The traditional calculation of breakeven point uses accounting flows in the formula. In order to calculate cash breakeven, remove depreciation from fixed costs and state sales when the cash is received.
3. Leverage
   1. DOL Calculation And Interpretation. The degree of operating leverage (DOL) of a firm is defined as the percentage change in ____ that occurs as a result of a percentage change in sales(Key Term). Firms with high operating leverage will enjoy a substantial increase in income as sales go up. But, conversely, as sales go down, their income will go down faster than firms with less operating leverage. For a real-world example of how operating leverage helps a company, check out this article on EMC Corporation and operating leverage .
   2. DFL Calculation and Interpretation. The degree of financial leverage is defined as the percentage change in earnings per share (EPS) that occurs as a result of a percentage change in operating income. Firms with high financial leverage will earn more return on equity as they aren't using as much equity to finance the firm but they are also riskier. The higher the financial leverage, the higher the risk.
   3. DCL Calculation and Interpretation. The degree of combined leverage allows is to calculate the effect of using both operating and financial leverage to magnify the returns for the firm. The DCL is calculated as the percentage change in earnings per share (EPS) as a result in a change in ____(Critical Concept).
   4. Summary. Take a look at the PowerPoint presentation for a summary of concepts and the formulas to calculate each.