The Effects of Fixed Costs on Operating Leverage
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What impact does fixed costs have on a company's operating leverage? What is the danger of being a highly levered company? (400+words)
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Solution Summary
The essay (>400 words) describes how fixed costs impact a a firm's operating leverage.
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A firm's operating leverage is defined by the following formula:
Operating leverage=Fixed Costs/Total Costs
Essentially, one way of considering operating leverage is as the percentage of fixed costs relative to the total costs of a firm or of a project.
Variable costs are those costs contributing to costs of goods produced or cost of goods sold (COGS). For example, if a manufacturer makes a widget that has $10 worth of direct materials (components needed to make the widget) and $10 worth of direct labor (the salary of the line worker who actually builds the widget) then the total variable cost to manufacture the widget is $20.
Of course, associated with this process, there will also be indirect or ...
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