What is financial and operating leverage?
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What is financial leverage? Why might a company that has a high degree of operating leverage not want to have a high degree of financial leverage? Are there exceptions to this "rule"?
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Solution Summary
This solution defines operating and financial leverage and discusses their differences in 358 words.
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Leverage generally refers to borrowing. If the firm's return on assets (ROA) is higher than the interest on the loan, then its return on equity (ROE) will be higher than if it did not borrow. On the other hand, if the firm's ROA is lower than the interest rate, then its ROE will be lower than if it did not borrow. Leverage is taking on debt as a source of financing.
Operating leverage reflects the extent to which fixed assets and associated fixed costs are utilized in the business. Degree of operating ...
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