1) ABC Company has mostly fixed costs and XYZ Company has mostly variable costs. Which company...

1) ABC Company has mostly fixed costs and XYZ Company has mostly variable costs. Which company has the greatest risk of a net loss? Why?

2) Briefly explain the concept of sensitivity analysis.

Solutions

Expert Solution

(1) ABC Company having mostly fixed cost have great risk than XYZ company having variable costs mostly.

The risk here is based on the operating leverage.If a company's variable costs are higher than its fixed costs, the company is using less operating leverage hence results in low business risk.A higher propotion of fixed costs in the production process means that the operating leverage is higher and the company has more business risk.

***Operating leverage is a measure of how much debt a company uses to finance its ongoing operations.Companies with high operating leverage must cover a larger amount of fixed costs each month regardless of whether they sell any units of product.Low-operating-leverage companies may have high costs that vary directly with their sales but have lower fixed costs to cover each month.***

(2)

A sensitivity analysis determines how different values of an independent variable affect a particular dependent variable under a given set of assumptions. It studies how various sources of uncertainty in a mathematical model contribute to the model's overall uncertainty. This technique is used within specific boundaries that depend on one or more input variables.It is used in the business world and in the field of economics. It is commonly used by financial analysts and economists, and is also known as a what-if analysis.

ekkarill92 answered 1 year ago

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