Leverage

Companies often use leverage to augment profits.  Based on what you learned this week, please explain the following in detail:

  • With regards to Operating Leverage, please explain why a company with HIGH Operating Leverage faces greater financial risk in a declining sales period compared to a company with LOW Operating Leverage.  (HINT: The key here is the relation between fixed costs and variable costs.)
  • What does a business’s Contribution Margin represent?  What does the Contribution Margin have to do with Operating Leverage?

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