Which of the following statements is CORRECT? As a firm increases the operating leverage used to produce a given quantity of output, this will
A) normally lead to a decrease in its business risk.
B) normally lead to a decrease in the standard deviation of its expected EBIT.
C) normally lead to a decrease in the variability of its expected EPS.
D) normally lead to a reduction in its fixed assets turnover ratio.
E) normally lead to an increase in its fixed assets turnover ratio.

Question

Quizplus · Accepted Answer

Operating leverage involves using a higher proportion of fixed costs to variable costs in the production process. As a firm increases its operating leverage, it commits to higher fixed costs relative to variable costs. This does not decrease business risk or the variability of expected EBIT or EPS; instead, it increases business risk because the firm must cover higher fixed costs regardless of sales volume. The fixed assets turnover ratio, calculated as sales divided by fixed assets, is likely to decrease because the firm is relying more on fixed assets (higher fixed costs) to generate sales, indicating less efficient use of fixed assets if sales do not increase proportionately.

Which of the Following Statements Is CORRECT? as a Firm