Question

Briefly explain the concept of operating leverage. If a company takes actions that reduce its operating leverage, how is it going to affect the equity beta of the company? Why?

Answer 1

Q- Briefly explain the concept of operating leverage. If a company takes actions that reduce its operating leverage, how is it going to affect the equity beta of the company? Why?

Answer- Operating leverage is a cost-accounting formula. These formula captures the relationship between a company's fixed costs and company's veriable costs with company's profit and help to set appropriate selling prices for company procucts.

The Operating leverage calculate a company's break even point where company have no profit and no loss.The higher the degree of operating leverage, the greater the potential danger from forecasting risk.

• If company with high operating leverage must cover a large amount of fixed cost.

• If company with Low-operating-leverage may have large amount of veriable cost.

If a company takes actions that reduce its operating leverage then high percentage of variable costs in company total costs, which means fewer units have to be sold to cover costs. It is going to affect the equity beta of the company because the firm earns a smaller profit on each incremental sales. In this condition company can not generate outsized profit because when operating leverage reduce the variable cost increase in total cost and which is effect by production.

The equity beta affected because companies profit is related to companies variable cost and company need to sell more number of product to generate more profit.