A firm with high operating leverage has :
High fixed cost in its production process
Operating leverage arises from fixed operating costs in the cost structure. The degree of operating leverage is \( \text{DOL} = \dfrac{\text{Contribution}}{\text{EBIT}} \), where contribution is sales minus variable costs.
The larger the fixed operating costs, the smaller EBIT is relative to contribution, so DOL is higher and a given percentage change in sales produces a larger percentage change in EBIT.
Therefore a firm with high operating leverage is one that uses a large proportion of fixed costs in its production process, for example a capital-intensive, highly automated plant.
Low fixed cost or high variable cost means a low operating leverage. Low variable cost often accompanies high fixed cost, but the defining feature of operating leverage is the fixed cost element, not the variable cost.
Hence, High fixed cost in its production process.
Similar Questions
Match the items of List - I with the items of List - II and find out the correct matching.
List - I List - II (Formulae) (Type of leverages) (a) \(\frac{\text{Contribution}}{\text{EBIT}}\) (i) Financial leverage (b) \(\frac{\text{EBIT}}{\text{Earnings before Tax (EBT)}}\) (ii) Super – leverage (c) \(\frac{\text{Contribution}}{\text{EBT}}\) (iii) Operating leverage Codes :
(a) (b) (c)
On the basis of the following information, what will be the EBIT corresponding to financial indifference point ?
Total capital outlay ₹ 60,00,000
Financing Plans
(a) 100% Equity @ ₹ 10/- per share
(b) Debt – equity ratio 2 : 1
Rate of interest 18% p.a., corporate tax rate 40%
Combined leverage is calculated as :
Financial Leverage is measured by :
The term ‘capital structure’ implies :
The benefits of debt financing over equity financing are likely to be highest in which of the following situations ?
The degree of super-leverage would be calculated by :
Assertion (A) : Arbitrage keeps the cost of capital constant despite change in the capital structure.
Reason (R) : It ensures compensating inverse change in cost of equity capital with a change in the cost of debt capital.
Codes :
The optimum capital structure of a company is planned as per considerations of
I. Profitability
II. Solvency
III. Marketability of shares
IV. Control
Codes :
A firm wants to know the Degree of Operating Leverage (DOL) with the following information :
Current level of sales : 6000 units
Break-even point sales : 4000 units
What would be the DOL ?
Important Questions from Capital structure
Choose the correct code for the following statements being correct or incorrect.
Statement I: Companies generally do not prefer low cost debt financing.
Statement II : Raising debts requires credit rating and payment of interest even if companies suffer losses.
- Which of the following theories of capital structure articulates that a firm borrows up to the point where the tax benefit from extra debt is exactly equal to the cost that comes from the increased probability of financial distress?
- The mean marks of $100$ students were found to be $45$. Later on it was discovered that at the time of computation two are wrongly taken as $23$ and $27$ instead of $32$ and $72$. What is the correct mean?
'That personal leverage can replace corporate leverage' is assumed by
The optimum capital structure is supported by which combination of the following ?
(i) Traditional theory
(ii) Net income theory
(iii) Pecking order theory
(iv) Net operating income theory
Choose the correct answer from the code given below:
