The Cost of Capital; Financial Leverage; Which Counts Most Term Paper

The Cost of Capital Financial Leverage Which Counts Most - Term musical theme ExampleThe high sale impart result in higher profits and a reducing in variable cost signifies that the organization does not stomach to incur any extra expenses for for each one building block sold. An increased volume of sales will enable to company to save gain benefits from its glacial be. The idea of run(a) leverage was initially developed for utilizing in capital budgeting. Operating leverage is a significant concept as it affects how responsive profits are to transforms into sales volume. The Degree of Operating leverage is a function of the cost structure of a steady and is usually defined in ground of the relationship between better cost and total costs. A firm that has high fixed costs relative to total costs is said to have operating leverage. A firm with high operating leverage will too have higher variability in operating income than would a firm producing a similar product with lo w operating leverage (Choi 20). Other things remaining the same, the high distinction in operating income will guide to a high beta for the industry with higher operating leverage. It is helpful to recognize how operating profit will vary with a given change in units formed operating leverage is helpful to decide the business risks. Operating leverage can also be understood as the degree to which an organization utilizes fixed costs in creating its goods or fling its facilities. A fixed cost contains advertising expenses, equipment and technology, administrative costs, taxes, and depreciation. However, it excludes interest on debt, which is an element of financial leverage. By using fixed production costs, an organization can raise its earnings. If an organization has a high quantity of fixed costs, it has a high level of operating leverage. High-tech and automated companies, airlines, utility companies etc commonly have high amounts of operating leverage. The difference between v ariable and fixed costs is an old idea. This separation of costs by behavior is the basis for breakeven analysis. The idea of break even analysis is based on the elementary question of how many units of product or service a business must sell in order to cover its fixed costs before beginning to make a profit. Presumably, unit prices are set at a level high enough to recoup all direct unit costs and leave a mete of contribution toward fixed cost and profit (Helfert 193). Once seemly units have been sold to accrue the total contribution require to offset every fixed costs, the margin from any extra units sold will become revenue unless a latest layer of fixed expenses has to be added at any future point to support the high volume. Understanding this attitude will enhance the insight into how operational features of a business involve the elements of financial projections and planning. This information is also effectual in setting operational strategies, which, particularly in an unstable business setting might, for instance, focus on reducing fixed costs during outsourcing certain operations. Cost of Capital The cost of capital means the required rate of return for making capital budgeting. Cost of capital comprises the cost of debt and the cost of equity acquired through different sources. Cost of capital is the average rate of return required by the investors for their long bourne investments such as equity fund, preference fund and long full term capital. When the firm makes long term investm