1. Breakeven and Financial Leverage By R. S. Miolla

2. Capital Structure The firm’s mixture of debt versus equity Shows how the firm has financed assets A = L + OE A firm should establish a target capital structure. Ex: 100% = 40% + 60%.

3. Cost Behavior Fixed Costs – Costs that do not vary with sales. Ex: leases, depreciation, property taxes, salaries Variable Costs – Costs that vary in direct proportion to sales. Ex: raw materials, factory labor, sales commissions Semi-Variable Costs – A mix. Ex: utilities, repairs and maintenance.

4. Breakeven Analysis VCPU: variable cost per unit Price: selling price of your product Fixed Costs: total fixed costs for a time period Computes NUMBER of units Breakeven Volume (#) = Fixed Costs Price – VCPU

5. Breakeven Example Fixed Costs = $60,000 Sell a cup of coffee for $2.00 VCPU = $.80 BE = 60,000 = 50,000 UNITS 2 -.80

6. Degree of Financial Leverage The key is how the firm is capitalized – how much debt versus equity DFL= % change in EPS % change in Operating Profit Impacts how risky the firm is. High DFL: Leveraged Low DFL: Conservative

7. DFL The more debt the firm has, the higher the DFL will be. DFL = Operating Profit Operating Profit - Interest Interest = interest expense

8. DFL Example Leveraged – Operating profit = 50,000; Interest = 25,000 – DFL= 50,000/(50,000 – 25,000) – DFL = 2 Conservative – Operating profit = 50,000 Interest = 5,000 (less debt) – DFL = 50,000/(50,000 – 5,000) – DFL = 1.1

9. Price to Earnings Ratio Called P/E ratio P/E = Market Price of a Stock EPS from most current year end