Fixed costs are those that _____________ with \n changes in the volume of production
do not change
Therefore: as sales increase,
fixed costs do not increase
The degree to which a firm locks into fixed costs is referred to as its
leverage position
The more highly leveraged a firm, the _________ it is because of the obligations related to fixed costs that must be met even if the firm is having a bad year with low sales
riskier
At the same time, the more highly leveraged, the greater the profits when
sales are high
Financial leverage is the extent to which a firm \n obtains capital from debt versus equity
(D/E ratio)
The greater the D/E ratio, the more highly leveraged the firm, because debt legally obligates the firm to annual interest payments (which are a ___________)
fixed costs
Operating leverage is concerned with the extent to which a firm commits itself to high levels of fixed costs _______________________
other than interest payments
\n A firm that rents property using cancelable leases has less leverage than with
non-cancelable leases
A firm that has substantial vertical integration has created a
highly leveraged situation
To a great degree, your desired leverage position depends on the degree to which your sales and profits ___________
fluctuate
The greater the fluctuation in sales and profits
the less leverage you can safely afford
If your firm is a _________, noncyclical firm, then \n use of debt will improve the rate of return earned by your shareholders
Stable
If cyclical factors in your industry or the economy at large tend to cause your business to have both good and bad years
then debt entails a greater risk
Both these financial decisionsâhow much financial leverage and how much operating leverage the firm should have
are fundamental to the firm
The level of operating leverage a firm selects \n should be based in part on input from the \n managers directly involved in the _______________
E.g., technology decisions affect companyâs _________ \n
Financial leverage decisions: CEO/CFO (top managers)
Production Process;
Operations
More often than not, the firms that have solvency problems are the ones that didnât formally address the
leverage issues head on
Contribution Margin = _______ â Variable Cost
Price
This margin represents the amount of money \n available to be used to pay fixed costs and provide the firm with ________ (also CM% = CM / Revenue)
profit
So if your selling price is lower than your variable cost per unit, you are ______________________!
guaranteed to lose money!
Operating leverage decisions are extremely \n important, but after-the-fact you canât do anything about it (sunk cost: ignore for decision-making)
Importance for profit discovery: what is/isnât profitable
Break-even Quantity
Fixed Costs / (Price â Variable Cost)
Break-even Quantity
Fixed Costs / (Contribution Margin)
Higher fixed _______________ increase the BEQ \n
But life is simple if there are no fixed costs (price > VC)
and variable costs
Larger fixed costs â higher operating leverage â places pressure on the __________________
volume of sales
Risk-return tradeoff: the lower the variability in our sales,
the lower the risk associated with high fixed costs
Your fixed cost is $595,000, your sales price is \n $1,500/unit, and your variable cost is $1,138/unit
\n How many units must you sell to break even? \n ($595,000) á (_______ â $1,138) = 1,643.6
\n You need to sell 1,644 units to break even
1,500
Youâre considering a $50,000 advertising campaign \n
($595,000 __________) á ($1,500 â $1,138) = 1,781.8 \n
You need to sell 1,782 units to break even
+50,000
Youâre considering lowering the price to $1,350 \n ($595,000) á ($1,350 _________) = 2,806.6 \n
You need to sell 2,807 units to break even
-1,138
This break-even analysis is an example of Cost- \n Volume-Profit (CVP) analysis that used to make \n business decisions
\n Planning tool that looks at the relationships among costs and volume and how they affect profits
Assumptions inherent in CVP analysis:
\n The _____________ per unit does not change with volume
Managers can classify each cost as fixed or variable \n
Fixed costs ____________ (do not change with volume) \n
Variable costs (per unit) do not change with volume
selling price;
are constant
Letâs consider a company that sells 2 products \n
A necessary assumption for breakeven analysis here is that the ______________ (% of units sold) is constant
product mix
Say their fixed cost is $88,000 and their sales mix is 75% Product A and 25% Product B \n ($88,000) á (____) = 16,000 weighted average units \n
You need to sell 16,000 weighted avg units to break even
\n Is this the same as just âsell 16,000 unitsâ? Why?
$5.50