Leverage and Break-even Analysis

Flashcards covering key terminology and concepts related to leverage, break-even analysis, and cost classification in financial management.

Leverage

The use of fixed-cost items to magnify returns at high levels of operation.

Break-even point

Occurs when total revenues equal total costs for a period, usually one year.

Linear break-even analysis

Assumes a linear relationship between revenues and costs, leading to higher profits as revenues increase.

Nonlinear break-even analysis

Considers a slower increase in revenue relative to costs, resulting in a second break-even point.

Degree of Operating Leverage (DOL)

Measures the percentage change in operating income as a result of a percentage change in volume.

Financial leverage

The extent to which debt is used in the capital structure of a firm.

Degree of Financial Leverage (DFL)

Measures the percentage change in earnings per share (EPS) for a percentage change in earnings before interest and taxes (EBIT).

Indifference Point

The level of operating income where results based on EPS are equal between two financing plans.

Fixed Costs

Costs that remain relatively constant regardless of the volume of operations.

Variable Costs

Costs that move directly with a change in volume.

Semi-Variable Costs

Costs that are partially fixed but change somewhat as volume changes.

Break-even analysis

A technique used to evaluate the implications of heavy capital asset use.

Opportunity Cost

The potential loss from choosing one alternative over another in terms of profit.

Risk Exposure

The potential of not achieving desired results, which increases with leverage.

Capital Budgeting

Strategic decisions related to investment that affect the extent of operating leverage.