Why does a conservative approach to operating leverage inhibit a firm’s profitab

Question

Why does a conservative approach to operating leverage inhibit a firm’s profitability? Your answer should, at a minimum, explain the concept of operating leverage and mention the roles of contribution margin and breakeven point.

What types of firms or what industry sectors might it be prudent to limit operating leverage? Why?

Why would a firm ever issue stock or find external sources of equity if they have the opportunity to leverage with debt?

Explore leverage as it related to the financial crisis of 2008/2009 and share what you learned.

Explanation / Answer

ans: a conservative approach to operating leverage will inhibit firms profitability because in conservative view they focus more on keeping the fixed cost lower and hence do not pay much attention towards controlling variable cost beyong a set target, their profitability decreases with increase of sales due to high variable cost.

Contribution margin is nothing but sales - variable cost the higher the contribution margin the better for increase sales if contribution marginn is high it can reach BreakEvenPoint quicker. BEP is a point where your entire fixed cost is covered with contribution that is point where no profit no gain occurs, com. should focus more on reaching at this point asap by reducing the variable increasing the contribution margin, since the fixed cost per units diminishes with every increase sales.

sectors which highly competative and have less scope of reducing variable cost miht limit the operating leverage such airline industries. Firm generally prefer equity to debt becasue debt carries an obligation to settle first at the time liquidation, they are paid before shareholders at the time of liquidation.

Related Questions

Navigate

• Browse (All)
• Browse W
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.