Suppose a firm uses a high degree of operating leverage and operates in an industry whose sales are greatly affected by changes in the overall level of economic activity.The riskiness of that firm's earnings stream will likely be greater than the earnings of a firm in the same industry which has a lower degree of operating leverage.

Question

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A firm with high operating leverage has a higher proportion of fixed costs in its cost structure, which means that small changes in revenue can have a significant impact on its profits. In an industry where sales are greatly affected by changes in the overall level of economic activity, a high degree of operating leverage amplifies the impact of these changes on the firm's earnings. Therefore, the riskiness of the earnings stream of a high operating leverage firm in such an industry is greater than that of a low operating leverage firm in the same industry.

Suppose a Firm Uses a High Degree of Operating Leverage