The risk-return tradeoff across alternative cost structures can be measured as operating leverage.

Question

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Operating leverage refers to the effect of fixed costs on the relationship between sales and profits. It reflects the degree to which a firm uses fixed costs in its cost structure. High operating leverage means a higher proportion of fixed costs, which results in greater profit potential, but also greater risk. The risk-return tradeoff is thus reflected in the level of operating leverage, which can vary depending on the cost structure of a firm.

The Risk-Return Tradeoff Across Alternative Cost Structures Can Be Measured