If a company has high operating leverage, what would be the likely effect on its risk and return?a.Higher risk and higher returnb.Higher risk and lower returnc.Lower risk and lower returnd.Lower risk and higher return
Question
If a company has high operating leverage, what would be the likely effect on its risk and return?a.Higher risk and higher returnb.Higher risk and lower returnc.Lower risk and lower returnd.Lower risk and higher return
Solution
The correct answer is a. Higher risk and higher return.
Operating leverage is a measure of how revenue growth translates into growth in operating income. It is a measure of leverage, and of how risky, or volatile, a company's operating income is.
A company with high operating leverage has a larger proportion of fixed costs in its cost structure, meaning it must generate enough sales volume to cover these fixed costs. If it can do this, it can generate a higher return. However, if sales volume falls, the company still has to cover its fixed costs, which can lead to higher risk.
So, a company with high operating leverage can potentially have a higher return, but it also has a higher risk.
Similar Questions
How does operating leverage impact a company?a.It increases fixed costs and reduces riskb.It only affects short-term financial decisionsc.It decreases variable costs and increases riskd.It has no impact on costs or riskCLEAR MY CHOICE
Which of the following statements about Operating Leverage and Risk from the lecture are TRUE:Someone with relatively high fixed costs and low variable costs will have a high level of operating leverage and a low risk of making a large loss if their income falls.Someone with relatively low fixed costs and high variable costs will have a low level of operating leverage and a high risk of making a large loss if their income falls
How does a high degree of financial leverage affect a company during economic downturns?a.It increases operational efficiencyb.It amplifies lossesc.It reduces lossesd.It has no impact on losses
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