Operating and Financial Leverage.ppt

1、Operating and Financial Leverage,5,1-2,Chapter Outline,What is leverage? Break-even analysis Operating leverage Financial leverage Combined leverage Potential profits or increased risk?,1-3,What is Leverage?,Use of special forces and effects to magnify or produce more than the normal results from a

2、given course of action Can produce beneficial results in favorable conditions Can produce highly negative results in unfavorable conditions,1-4,Leverage in a Business,Determining type of fixed operational costs Plant and equipment Eliminates labor in production of inventory Expensive labor Lessens o

3、pportunity for profit but reduces risk exposure Determining type of fixed financial costs Debt financing Substantial profits but failure to meet contractual obligations can result in bankruptcy Selling equity Reduces potential profits but minimize risk exposure,1-5,Operating Leverage,Extent to which

4、 fixed assets and associated fixed costs are utilized in a business Operational costs include: Fixed Variable Semivariable,1-6,Break-Even Chart: Leveraged Firm,1-7,Break-Even Analysis,The break-even point is at 50,000 units, where the total costs and total revenue lines intersect Units = 50,000 . To

5、tal Variable Fixed Costs Total Costs Total Revenue Operating Income Costs (TVC) (FC) (TC) (TR) (loss) (50,000 X $0.80) (50,000 X $2) $40,000 $60,000 $100,000 $100,000 0,1-8,Break-Even Analysis (contd),The break-even point can also be calculated by: Fixed costs = Fixed costs = FC Contribution margin

6、Price Variable cost per unit P VC i.e. $60,000 = $60,000 = 50,000 units $2.00 - $0.80 $1.20,1-9,Volume-Cost-Profit Analysis: Leveraged Firm,1-10,A Conservative Approach,Some firms choose not to operate at high degrees of operating leverage More expensive variable costs may be substituted for automat

7、ed plant and equipment This approach may cut into potential profitability of the firm,1-11,Break-Even Chart: Conservative Firm,1-12,Volume-Cost-Profit Analysis: Conservative Firm,1-13,The Risk Factor,Factors influencing decision on maintaining a conservative or leveraged stance include: Economic con

8、dition Competitive position within industry Future position stability versus market leadership Matching an acceptable return with a desired level of risk,1-14,Cash Break-Even Analysis,Helps in analyzing the short-term outlook of a firm Noncash items are excluded: Depreciation Sales (accounts receiva

9、ble rather than cash) Purchase of materials Accounts payable,1-15,Degree of Operating Leverage (DOL),Percentage change in operating income Occurs as a result of a percentage change in units sold Computed only over a profitable range of operations Directly proportional to the firms break-even point D

10、OL = Percent change in operating income Percent change in unit volume,1-16,Operating Income or Loss,1-17,Computation of DOL,Leveraged firm: DOL = Percent change in operating income = $24,000 X 100 Percent change in unit volume $36,000 20,000 X 100 80,000 = 67% = 2.7 25% Conservative firm: DOL = Perc

11、ent change in operating income = $8,000 X 100 Percent change in unit volume $20,000 20,000 X 100 80,000 = 40% = 1.6 25%,1-18,Algebraic Formula for DOL,DOL = Q (P VC) Q (P VC) FC Where, Q = Quantity at which DOL is computed P = Price per unit VC = Variable costs per unit FC = Fixed costs For the leve

12、raged firm, assume Q = 80,000, with P = $2, VC = $0.80, and FC = $60,000: DOL = 80,000 ($2.00 - $0.80) ; 80,000 ($2.00 - $0.80) - $60,000 = 80,000 ($1.20) = $96,000 ; 80,000 ($1.20) - $60,000 $96,000 - $60,000 i.e. DOL = 2.7,1-19,Limitations of Analysis,Weakening of price in an attempt to capture an

13、 increasing market Cost overruns when moving beyond an optimum-size operation Relationships are not fixed,1-20,Nonlinear Break-Even Analysis,1-21,Financial Leverage,Reflects the amount of debt used in the capital structure of the firm Determines how the operation is to be financed Determines the per

14、formance between two firms having equal operating capabilities BALANCE SHEET Assets Liabilities and Net Worth Operating leverage Financial leverage,1-22,Impact on Earnings,Examine two financial plans for a firm, where $200,000 is required to carry the assets Total Assets = $200,000 Plan A (leveraged

15、) Plan B (conservative) Debt (8% interest) $150,000 ($12,000 interest) $50,000 ($4,000 interest) Common stock 50,000 (8000 shares at $6.25) 150,000 (24,000 shares at $6.25) Total financing $200,000 $200,000,1-23,Impact of Financing Plan on Earnings per Share,1-24,Financing Plans and Earnings per Sha

16、re,1-25,Degree of Financial Leverage,DFL = Percent change in EPS Percent change in EBIT For the purpose of computation, it can be restated as: DFL = EBIT . EBIT I Plan A (Leveraged): DFL = EBIT = $36,000 = $36,000 = 1.5 EBIT I $36,000 - $12,000 $24,000 Plan B (Conservative): DFL = EBIT = $36,000 = $

17、36,000 = 1.1 EBIT I $36,000 - $4,000 $32,000,1-26,Limitations to Use of Financial Leverage,Beyond a point, debt financing is detrimental to the firm Lenders will perceive a greater financial risk Common stockholders may drive down the price Recommended for firms that are: In an industry that is gene

18、rally stable In a positive stage of growth Operating in favorable economic conditions,1-27,Combining Operating and Financial Leverage,Combined leverage: when both leverages allow a firm to maximize returns Operating leverage: Affects the asset structure of the firm Determines the return from operati

19、ons Financial leverage: Affects the debt-equity mix Determines how the benefits received will be allocated,1-28,Combined Leverage Influence on the Income Statement,1-29,Combining Operating and Financial Leverage,1-30,Operating and FinancialLeverage,1-31,Degree of Combined Leverage,Uses the entire in

20、come statement Shows the impact of a change in sales or volume on bottom-line earnings per share DCL = Percentage change in EPS ; Percentage change in sales (or volume) Using data from Table 5-7: Percent change in EPS = $1.50 X 100 $1.50 = 100% = 4 Percent change in sales $40,000 X 100 25% $160,000,

21、1-32,Degree of Combined Leverage (contd),DCL = Q (P VC) , Q (P VC) FC I From Table 5-7, Q (Quantity) = 80,000; P (Price per unit) = $2.00; VC (Variable costs per unit) = $0.80; FC (Fixed costs) = $60,000; and I (Interest) = $12,000. DCL = 80,000 ($2.00 - $0.80) = 80,000 ($2.00 - $0.80) - $60,000 - $

22、12,000 = 80,000 ($1.20) = 80,000 ($1.20) - $72,000 DCL = $96,000 = $96,000 = 4 $96,000 - $72,000 $24,000,Working Capital and the Financing Decision,6,1-34,Chapter Outline,Working capital management Current asset management Asset financing Long-term versus short-term financing Risk and profitability

23、vis-vis asset financing Expected value analysis may sometimes be employed,1-35,Working Capital Management,The financing and management of the current assets of a firm Crucial to achieving long-term objectives of the firm or its failure Requires immediate action,1-36,The Nature of Asset Growth,Effect

24、ive current assets management requires matching of the forecasted sales and production schedules Differences in actual sales and forecasted sales can result in: Unexpected buildup. Reduction in inventory, affecting receivables and cash flow Firms current assets could be: Self-liquidating Permanent c

25、urrent assets.,1-37,The Nature of Asset Growth (contd),1-38,Controlling Assets Matching Sales and Production,Fixed assets grow slowly with: Increase in productive capacity Replacement of old equipment Current assets fluctuate in the short run, depending on: Level of production versus the level of sa

26、les When production is higher than sales the inventory rises When sales are higher than production, inventory declines and receivables increase,1-39,Controlling Assets Matching Sales and Production (contd),Cash budgeting process Level production method Smooth production schedules Use of manpower and

27、 equipment efficiently to lower cost Match sales and production as closely as possible in the short run Allows current assets to increase or decrease with the level of sales Eliminates the large seasonal bulges or sharp reductions in current assets,1-40,Matching Sales and Production-McGraw-Hill Comp

28、anies, Inc.,A good example of seasonal sale Has significant share of sales and earnings in the third and fourth quarters Due to seasonal nature of textbook publishing Lenders and financial managers need to plan inventory Lack of correct inventory planning can lead to lost sales,1-41,Quarterly Sales

29、and Earnings Per Share for McGraw Hill,1-42,Seasonal Sales Pattern in Target and Limited Brands,Like publishers, retail companies do not stock inventory for more then a year Fourth quarter is the biggest quarter for retailers As per the figure, the Target is growing much faster than the Limited Bran

30、ds Even then, in the fourth quarter, peak earnings are almost equal for both the companies,1-43,Quarterly Sales and Earnings Per Share, Target and Limited Brands,1-44,Point-of-Sales Terminals,Retail-oriented firms use new, computerized inventory control systems linked online Digital inputs or optica

31、l scanners Helps adjust orders or production schedules Radio Frequency Identification (RFID),1-45,Temporary Assets under Level Production An Example,Yawakuzi Motorcycle Company Sales fluctuations: High sales demand during early spring and summer; sales drop during October through March Decision: App

32、ly level production method - 12-month sales forecast is issued Result: Level production and seasonal sales combine to produce fluctuating inventory,1-46,Yawakuzi Sales Forecast (in units),1-47,Yawakuzis Production Schedule and Inventory,1-48,Sales forecast, cash receipts and payments, and cash budge

33、t,OctNovDecJanFebMarAprMayJuneJulyAugSept,Sales (units)300150500 0 6001,0002,0002,0002,0001,000500 Sales $0.9$0.45$0.15 0 0 $1.8$3.0$6.0$6.0$6.0$3.0$1.5 (unit price, $3,000),Sales Forecast ($ millions),50% cash .45 $.225 $.075 0 0 $0.9 $1.5 $3.0 $3.0$3.0$1.5$.75 50% cash from prior months sales .75*

34、 0.450 0.225 0.075 0 0 0. 9 1.5 3.03.0 3.0 1.50 Total cash receipts $1.20 0.675 $0.300 $0.075 0 $0.9 $2.4 $4.5 $6.0 $6.0$4.5 $2.25 *Assumes September sales of $1.5 million.,Cash Receipts Schedule ($ millions),PPT 6-11,1-49,Constant production of 800 units/month (cost $2,000 per unit)$1.6$1.6 $1.6 $1

35、.6 $1.6 $1.6 $1.6 $1.6 $1.6 $1.6 $1.6 $1.6 Overhead.4 .4 .4 .4 .4 .4 .4 .4 .4 .4 .4 .4 Dividends required minimum balance is $0.25 million),PPT 6-12,Sales forecast, cash receipts and payments, and cash budget,Assumes cash balance of $0.25 million at the beginning of October and that this is the desi

36、red minimum cash balance.,1-50,Sales Forecasts, Cash Receipts, and Payments, and Cash Budget (contd),Table 6-3 is created to examine the buildup in accounts receivable and cash Sales forecast: Based on assumptions taken earlier (table 6-1) Cash receipts: 50% cash collected during the month of sale a

37、nd 50% pertains to the prior month Cash budget: a comparison of cash receipt and payment schedules to determine cash flow,1-51,Total Current Assets, First Year ($millions),1-52,Cash Budget and Assets for II Year With No Growth in Sales ($millions),1-53,Yawakuzis Nature of Asset Growth,1-54,Hedged Ap

38、proach to Financing,Match liquidity (life) of your assets to the maturity (term) of your financing Means your assets will be generating cash when your liabilities come due (this reduces risk) Balanced Financing Temporary (seasonal) build-up in inventory and accounts receivable finance with trade cre

39、dit, short-term bank loans, short-term notes payable Permanent (minimum) levels of inventory, receivables + Property and equipment, long-term investments finance with long-term loans, leases, bonds, capital stock, retained earnings,PPT 6-17,1-55,Matching Long-Term and Short-Term Needs,1-56,Alternati

40、ve Plans,It is important to consider other alternatives The challenge of constructing a financial plan is to prioritize the current assets into temporary and permanent The exact timing of asset liquidation, even in the light of ascertaining dollar amounts is onerous It is also difficult to judge the

41、 amount of short-term and long-term financing available,1-57,Long-Term Financing,Firms can be assured of having adequate capital at all times: Use long-term capital to cover part of the short-term needs Long-term capital can be used to finance: Fixed assets Permanent current assets Part of the tempo

42、rary current assets,1-58,Using Long-Term Financing for Part of Short-Term Needs,1-59,Short- Term Financing,Small businesses do not have total access to long-term financing They rely on short-term bank and trade credit Advantage: interest rates are lower Short-term finances are used finance: Temporar

43、y current assets Part of the permanent working capital needs,1-60,Using Short-Term Financing for Part of Long-Term Needs,1-61,Short-Term vs. Long-Term Financing,Short-term financing is less expensive but riskier lower interest rates (usually) short-term rates are volatile risk of default if sales sl

44、ow down risk that bank may not extend / renew loans Long-term financing is more expensive but less risky usually higher interest rates, you may pay interest on funds you dont always need you have capital at all times Firm must decide the appropriate “mix”,PPT 6-21,1-62,Term Structure of Interest Rates,The Term Structure of Interest Rates is also known as the Yield Curve A graph showing the interest rate for Government of Canada securities with different maturity dates Normally, long-term rates are higher than short-term rates,1-63,A. Flat yield curve, March 1999,PPT 6-12