1. 1 of 29 ©2012 McGraw-Hill Ryerson Limited Learning Objectives 1.Calculate break-even in units and in dollars. (LO1) 2.Define leverage as a method to magnify earnings available to the firm’s common shareholders. (LO2) 3.Define and calculate operating leverage and assess its opportunities and limitations. (LO3)

2. 2 of 29 ©2012 McGraw-Hill Ryerson Limited What is Leverage? 2 types of leverage: 1.Operating Leverage = the degree to which capital assets and associated fixed costs are utilized 2.Financial Leverage = the amount of debt used in the capital structure (debt/equity mix) Balance Sheet AssetsLiabilities and Equity Current assets Debt (Loans, bonds, leases) Operating (Interest charges ) Financial LeverageCapital assets Equity (shares) Leverage (fixed charges) LO3

3. 3 of 29 ©2012 McGraw-Hill Ryerson Limited 0$(60,000)$(12,000) 20,000(36,000)(4,000) 40,000(12,000)4,000 60,00012,000 12,000 Indifference point 80,00036,000 20,000 100,00060,000 28,000... Leveraged Firm Conservative Firm (Table 5-3) (Table 5-4) Units Income(Loss) Income (Loss) Table 5-5 Operating income or loss LO3

4. 4 of 29 ©2012 McGraw-Hill Ryerson Limited Figure 5-3 Nonlinear break-even analysis Profit Loss LO3

5. 5 of 29 ©2012 McGraw-Hill Ryerson Limited Formula Review LO2/LO3/LO4 DCL = DOL × DFL