Question

Why are companies with higher operating leverage and or high finacial leverage more risky? ( hint...

Why are companies with higher operating leverage and or high finacial leverage more risky? ( hint break even) Remember operating leverage is the extend a company utilizes fix costs. Financial leverage is the company's use of debt to finance the business.

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Answer #1

High financial leverage uses a lot of debt to finance the business and so high debt will lead to high interest in the debt taken. This high interest will reduce the operating income and so the net income would be less if the company has high financial leverage. This leads to lower profitability and low ROE

High operating leverage uses high proportion of fixed costs. In case of high operating leverage a slight difference in sales results in huge difference in operating income and this makes it risky. In case the sales diminish slightly, the operating income diminishes in a huge way because of the fixed costs.

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