Amalagmated Mining has very high operating leverage due to the capital intensisv

Question

Amalagmated Mining has very high operating leverage due to the capital intensisve nature of the steel business. The firms CEO is concerned about the variability in the firms EPS is sales should drop, and decides to take action. Which of thee following will reduce the variability in the firms EPS for a given change in sales?

A-The CEO may decrease the firms financial leverge, thus lowering thee firms total leverage

B-The CEO may increase the firms financial leverage and hence reduce the varability by using non-shareholder money to support the business

C- The CEO may issue moree corporate bonds and use the proceeds to pay off short-term liabilities.

D- The CEO may increase the firms total leverage by raising money from the sale of the common stock

Explanation / Answer

Option A.

Combined leverage tells the relationship between firm’s sales and EPS.

Combined leverage is operating leverage times financial leverage. Therefore, by reducing any of these leverage, firm can decrease the combined leverage.

Option A talks about lowering financial leverage, so option A is correct.

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