CHAPTER 8

OPERATING AND
FINANCIAL LEVV VERAGE

INTRODUCTION

items to magnity the firm's results

is
Te:

Leverage represents the use offixed costs

leverage two-edged
is a swod
however, important to keep in mind that
well, and quite the opposit
posit
favorable results when things go
producing highly
under negative conditions.

LEVERAGE IN A BUSINESS
Assume that there exists an opportunity to start your own business. You are to
manufacture and market industrial parts, such as ball bearings, wheels and casters
You are faced with two primary decisions.

First, you must determine the amount of fixed cost plant and equipment you wish
to use in the production process. By installing modern, sophisticated equipment,
you can virtually eliminate labor in the production of inventory. At high volume,
you will do quite well, as most of your costs are fixed payments for plant and
equipment. If you decide to use expensive labor rather than machinery, you will
lessen your opportunity for profit, but at the same time, you will lower your
exposure to risk (you can lay off part of the workforce).

Second, you must determine how you will finance the businss. If you rely on debt
financing and the business is successful, you will generate substantial profits as an
Owner, paying only the fixed costs of debt. Of course. if the business starts off
poorly, the contractual obligations related to debt could mean bankruptcy. As an
alternative, you might decide to sell equity rather than borrow a step that will lower
your own profit potential but minimize your risk exposure.

In both decisions, you are

making very explicit decisions about the use of leverage.
To the extent that you go with a
heavy commitment to fixed costs in the operation
of the firm, you are
employing operating leverage. To the extent that you utilize
debt in the financing of the firm,
you are engaging in financial leverage. We sna
carefully examine each type of
leverage and then show the combined effect
both. o
 Operating and Financial Leverage
CVP ANALYSIS
159

olume-profit (CVP) analysis is

powerful tool and vital in many business
a
isions because t helps managers understand the
relationships among cost,
lume and profit. CVP analysis focused on how profits
vol
affected by the
are
following elements (a) selling prices, (b) sales volume, (c) unit variable
total fixed costs, and (e) mix of products sold. costs. (d)

This model is used to answer a

variety of critical questions such as:

What is the company's breakeven volume?

What is its margin of safety?

What is likely to happen if specific changes are made in
volume? prices, costs and

Financial managers need to know the costs that are likely to be incurred under
normal operating conditions and how
they might vary if conditions change. They
need to understand which costs would stay the same and which costs would follow
the movement of volume and so on.

If the above items are known, the following relationships may be established:

Contribution Margin per unit or marginal income per unit

This is the excess of unit selling price over unit variable costs and
the amount each unit sold contributes toward
1) covering fixed costs and
2) providing operating profits.

Formula:
CM per unit = Unit selling price - unit variable costs

Contribution Margin ratio

This is the percentage of contribution margin to total sales. This
ratio is computed as follows:

CM ratio
Contribution Margin
Sales
 i60Chapter8 shows how the contributin.
useful in that it
The CM ratio is very peso change
in total sales.
given
by a it m e a n s that for each na
affected
margin will be CM ratio is 40%,
instance, ifa company's
contribution
will increase
margin PO.40 by
increase in sales, total PO.40 assuming that there aare
will increase by
Net income likewise
costs.
no changes in fixed
valuable in those
situations where the
The CM ratio is particularly selling price
between change in and
manager must
make trade-offs
variable costs.
change in
PLANNING
CVP ANALYSIS FOR BREAKEVEN

is to determine the
break-even point,
The starting point in many business plans
total revenues and total
volume where
Break-even point is the level of sales loss. This point can be
are equal, that is, there
is neither profit or
expenses Break-even point can be computed as follows:
determined by using CVP analysis.
Total Fixed Costs
I. Break-even point (units) Contribution Margin per unit

Total Fixed Costs

Variable Costs
2. Break-even point (pesos) =
1 Sales

3. a. Break-even sales Total Fixed Costs

for multi-products Weighted Average
firm (combined units) Contribution Margin

b.
b Weighted Contribution
Margin per unit

Unit CM x No. of units Unit CM x No. of units

per Mix per Mix

Total number of units per Sales Mix

 Operating and Financial
a. Break-even sales for Ieverage 161
4.
multi-products firm Total Fixed Costs
(combined pesos) Weighted CM ratio
b. Weighted CM ratio Total Weighted CM (P)
Total Weighted Sales (P)
CVP ANALYSIS FOR REVENUE AND CoST PLANNING

cVP analysis can be usea to aetermine the

level of
eired level of profit. In revenue planning, CVP sales needed to achieve a

determining the revenue required to achieve a desiredanalysis assists managers in

profit level. The eguation
that may be used to compute for target sales follows:

Sales (units) = Total Fixed Costs+ Desired

Profit
Contribution Margin Per Unit
or

Total Fixed Costs Desired

Sales (P) + Profit
Contribution Margin Ratio

ASSUMPTIONS AND LIMITATIONS OF CVP ANALYSIS

CVP analysis constitutes a very important tool for management

planning. Certain
underlying assumptions upon which it rests, however, place definite
the conclusions which can be limitations on
drawn from its results. Whenever the
underlying
assumptions of CVP analysis do not correspond to a given situation, the
limitations, of the analysis must be clearly
be useful and recognized if the break-even tool is to
educational.
In summary, the
following static
of a given break-even assumptions will limit the precision and reliability
analysis:
Assumption/Limitation Comment
. The analysis
is valid for a I. Failure to observe these limits
limited range of values the -

would lead to working with

"relevant" and a limited perio
-

unrealistic data.
of time.
 162 Chapter 8

All costs can be categorized as 2. Semi-variable costs present a

problem that can be solved by
fixed or variable.
segregating fixed and variable
portion.

a. There is a danger that

a.
Variable costs change
proportionately with linear cost and revenue
volume within the relevant relationship may be used
volume range. when nonlinearities are
significant.
b. Fixed costs are constant b. Non-linear curves often
within the relevant volume have optimum quantities;
linear ones do not.
range.
3 Revenues change 3 Price is constant for all volumes
proportionately with volumnes within the relevant range.
with selling price remaining
constant.

4. There is a constant product mix. 4 Data should be adjusted for any

shifts in product mix.

5. Changes in volume alone are There are other factors affecting

responsible for changes in costs costs and revenues, but they are
and revenues. lessened if narrow time and
volume limits are applied.

6. There is no significant change'in 6. Data should be adjusted if

inventories (i.e., in physical inventories change markedly.
units, sales volume equals
production volume.)
7. 7. This should be supported with
Operation leverage questions
can be dealt with in the CVP capital budgeting approaches
framework. that consider the time value of
money.
8. Uncertainly and a probabilities
8. The analysis is deterministic and be introduced.
appropriate data can be found. approach can

SALES MIX

Sales mix refers to the relative company's products are sola.

proportions in which a

The idea is to achieve the combination, or mix that will yield the greatest amount
not
of profits. Most companies have many products, and often these products are
s
equally profitable. Hence, profits will depend to some extent on the company
make
sales mix. Profits will be greater if high-margin rather than low-margin items
up a relatively large proportion of total sales.
 Operating and F inuncial Leverage
163
the sales miX can cause
Change
the perplexing
sales mix from high-marginvariations in company profits.
a
A shift
items to low-margin items
rofits to decrease even
though total sales may increase.
causecan

in the
mix fro
sales low-margin items to high-margin items canConversely. shift a

cause the reverse

total profits may increase even though total sales
effect; decrease. It is one thing to
rticular sales volume, it is quite another to sell
hieve a
the most
of products.
profitable mix
sfrative Case 8-1. CVP Analysis for a Multi-Products Firm

f nroduces only two products, A and B. These account for 60% and 40%
tatal sales pesos of Lor's
respectively. Variable costs as a
percentage
sales nesos are 60% for A and 85% for B. Total fixed costs are P150.000. There of
other costs.
are no

Required:

1. Compute the weighted contribution margin ratio.

2 Compute the break-even point in sales pesos.

3. Compute the sales pesos necessary to

generate a net income of P9,000 if total
fixed costs will increase by 30%.

Solution: Lor, Inc.

A B
1. Sales mix ratio
60% 40%
Multiplied by: Contribution margin ratio 40% 15%
Weighted Contribution margin ratio 24% + 6% = 30%

Fixed costs
2 BEP (P)
Weighted CMR
P150,0000
30%
P500,000
 164 Chapter 8 P 9,000
Desired net income
Add: Total Fixed costs
(PI50,000 x 130%) 195.000
P204,000
Contribution margin
Divided by: Weighted CMR 30%
Sales necessary to generate
P680,000
desired net income

OPERATING LEVERAGE
Operating leverage is a measure of how sensitive net operating income is to a
given percentage change in peso sales. Operating leverage acts as a multiplier. 1
operating leverage is liigh, a small percentage increase in Sales can produce a much

income.
larger percentage increase in net operating
Operating leverage can be illustrated with use of the following data for two manpo
farms, Green Farm and Yellow Farm.

Green Farm Yellow Farim

Expected Present
Present Expected
Sales P100,000 P110.000 P100,000 P110,000
Variable expenses 60,000 66,000 30,000 33.000
Contribution Margin 40,000 44.000 70,000 77,000
Fixed expenses 30,000 30,000 60,000 60,000
Net operating income P10,000 14,000 10.000 17,000
DEGREE OF OPERATING LEVERAGE

The degree of operating leverage at a given level of sales is computed by the

tollowing formula:

Degree of operating leverage Contribution margin

Net operating income
The degree of operating leverage is a measure, at a given level of sales, of how a
percentage change in sales volume will affect profits. To illustrate. the degree o
operating leverage for the two farms at Pl00,000 sales would be computed as
follows:

Green Farm P40,000 4

P10,000
 Operaling und F inancial Leveruge 165
Yellow Farm P70,000
P10,000
degree of operati
Because
the leverage
for Green Farm is 4,
the farm's net
operating income grows four times
fast as its sales. In
as
operating income grows seven times as fast
contrast, Yellow Farm's
as its saBes.
Thus, if sales increase
10%.
by
by
then we can expect ne net operating income of Green Farm to
times this amount, or by 40% and the net operating income of Yellow increase
Farm

to increase by seven times this amount or by 70%.

Percent Increase Degree of Percent Increase

in Sales Operatingg in Net Operating
Leverage Income

Green Farm 10% 4

()x (2)
40%
Yellow Farm 10% 70%

What is responsible for the higher operating leverage at Ycilow Farm? 1he only
difference between the two farms is their cost structure. If two companies have the
same total revenue and same total expense but different cost structures, then the
company with the higher proportion of fixed costs in its costs structure will have
higher operating leverage.

Alternative Approach

Degree of Operating Leverage (DOL) is also viewed as the perceniage change in

operating income that occurs as a result of a percentage change in units sold.

Degree of operating leverage Percent change in operating income

Percent change in unit volume

LIMITATIONS OF ANALYSIS

Throughout the analysis of operating leverage, it is assumed that a constant or

linear function exists for revenues and costs as volume clanges. For example, P2
was used as the hypothetical sales price at all levels of operation. In the "eal
an
worid" however, the firm face price weakness as an attempt to capture
may
overruns if there iS
ncreasing market for the product is made or it may face cost as
optimum-size operation. Relationships
are not as tixed
OVement beyond an
have been assumed.
 166 Chapter 8
Relationship
lustrative Case 8-2. Operating Leverage/CVP

sells a specialized cordless telephone for hiol

and
Voltar Company manufactures
environments. The company'S contribution forma t
electromagnetic radiation
beloW:
income statement for the most recent year is given

Percent of
Total Per Unit Sales

Sales (20,000 units) P1,200,000 P60 100%

Variable expenses 900,000 45 2%
Contribution margin 300,000 PI5 2%
Fixed expenses 240,000
Net operating income P 60,000
Management is anxious to increase the company's profit and has asked for an
analysis of a number of items.

Required:
Compute the company's CM ratio and variable expense ratio.
2. Compute the company's break-even point in both units and sales pesos. Use
the equation method.
3. Assume that sales increase by P400,000 next year. If cost behavior
patterns
remain unchanged, by how much will the
company's net operating income
increase? Use the CM ratio to compute the answer.
4. Refer to the original data. Assume that
next year management wants the
company to earn a profit of at least P90,000. How many units will have to be
sold to meet this targetprofit?
5. Refer to the original data. Compute the company's margin of safety in both
peso and percentage form.
6. a. Compute the company's degree of operating leverage at the present level
of sales.
b. Assume that through a more intense effort
sales increase
by the sales staff, the company's
by 8% next year. By what percentage would you expect net
operating income to increase? Use the degree of operating leverage to
obtain your answer.
 Operaung und Financiul Ieverage
vour
:fu your
c. Verify answer (D) by
to
16
statement showwing an 8% preparing new contribution format income
a
increase in sales.
ffort to increase sales and profits,
7. In management is considering the use of
ioher-quality speaker neC
nigner-quality
n P3 per unit, but management couldspeaker would incrcase variable
a

eliminate one quality

i s paid a salary or PSu,000 per year. The sales inspector
manager estimates
her-quality speaker would increase annual sales by at least 20%. that the
A SSuming that changes are made as
described
eantribution format income statement for next above, prepare a projected
a.

and percentage basis.

year. Show data on a total
per unit,
b. Compute the company's new break-even point in both units and
sales. Use the formula method. pesos of

C.Would you recommend that the changes be made?

Solution:

1.

Unit contribution margin_ P15

CM ratio 25%
Unit selling price P60

2
Variable Variable expense P45
expense ratio 15%
Selling price P60

Increase in sales P400,000

Multiply by the CM ratio x 25%
Expected increase in contribution margin P100.000
Because the fixed expenses are not expected to change, net operating income
Will increase by the entire Pl00,000 increase in contribution margin conmputed
above.
 168
Chapter8
4. bquation method:

Unit CM x Q- Fixed expenses

Profit
Q-P240,000
P90,000 (P60-P45) x
P90,000 +P240,000
PI5Q
P330,000 PI5
Q 22,000 units

Formula method:

Target profit + P90,000 +

Unit Sales
to attain Fixed expenses =P240,000
22,000
the target Contribution PI5 per units
profit margin per unit unit

Margin of Total sales -

Break even sales

safety in pesos
P1,200,000 P960,000 =P240,000

Margin of Margin of
= P 240,000 = 20%
safety safety in pesos
Total sales P1.200.000
percentage

6.

P 240.000
. Margin of Margin of safetyin pesos
Total sales P1,200.000 20%
safety
percentage

b.
Expected increase in sales 8%
Degree of operating leverage x5
Expected increase in net operating income 40%
 Operating and Financial ieverage 169
Ceales increase by 8%, then 21,6000 units (20,000 1.08
C.
cald next year. The neW
x
21.600)
contribution format income statement
will
be as follows:
would

Total Per Unit Percent

of Sales
Sales (21,600 units) P1,296,000 P60 100%
Variable expenses 972,000 45 75 o
Contribution margin 324,000 PI5 25%
Fixed expenses 240,000
Net operating income P 84,000
Thus, the P84,000 expected net operating income for next
year represents
a 40% increase over the Fo0,000 net operating income earned during the
current year:

P84,000-P60,000 P24,000
P60,000 P60,000 40% increase

Note from, net income statement above that the increase in sales from
20.000 to 21,600 units has increased both total sales and total variable
expenses.

7. a. A 20% increase in sales would result in 24,000

units x 1.20 = 24,000 units.
being sold next year: 20,000

Total Per Unit Percent

of Sales
Sales (24,000 units) P1,440,000 P60 100%
Variable expenses 1,152,000 48** 80%
Contribution margin 288,000 P12 20%
Fixed expenses 210,000*
Net operating income P 78,000
b.
Unit sales to breakeven Fixed expenses
Unit contribution margin

P210,000 17.500 units

P12 per unit
 170 Chapter 8
Fixed expenses
Peso sales to breakeven
CM ratio

P210,000 P1,050,000
0.20

should be made. The chanoe

these data the changes
C. Yes, based on
income from the present P60,000 t
increase thecompany's net operating result in a higher break-even
Although the changes also
P78,000 per year. 16,000 units), the
as compared
to the present
point (17,500 units than before:
becomes greater
company's margin of safety actually

Breakeven sales
Margin of safety Total sales
in pesos

= PI,440,000
P1,050,000 P390,000

*P240,000 P30,000 P210,000

P48+ P60
=
80%
**P45 +P3 =
P48;

FINANCIAL LEVERAGE

of fixed costs on the operations of the firm (operating

Having discussed the effect
leverage
Financial reflects
the second form of leverage.
turn to
ieverage), we now
Because debt carries a
structure of the firm.
the amount of debt used in the capital to greatly magnify
we have the opportunity
fixed obligation of interest payments, the real estate
You may have heard of
Our results at various levels of operations.
and will enjoy an
who borrows 100 percent of the costs of his project
developer well.
infinite return on his zero investment if all goes

as primarily affecting
the left-hand side
It is helpful to think of operating leverage
of the statement of financial position and financial
leverage as affecting the right-
hand side.
Statement of Financial Position

Assets Liabilities and Owners Equity

Operating Leverage Financial Leverage

Whereas operating leverage influences the mix of plant and equipment. financial
firms
leverage determines how the operation is to be financed. It is possible for two
because
have equal operating capabilities and yet show widely different results
to
of the use of financial leverage.
 Operating and Financiai Leverage
IMPACT ON EARNINGS 171
the impact of financial
In studyi
firm, each employing leverage, we shall examine two financial
a
significantly different amount of debt in plans
structure. Financing totaling P200,000 is required to carry the the capital
assets of the fim.
Total Assets P200,000
Plan A
(Leveraged) Plan B
Debt (8%6 (Conservative)
interest)
PI50,000 (P12,000 interest)
Common (8,000 shares at P50,000 (P4,000 interest)
stock 50,000 P6.25) (24,000 shares at
Total
150,000 P6.25)
financing P200,000 P200,000
Under leveraged Plan A, we will
borrowPI50,000 and sell 8,000 shares of stock
at P6.25 to raise an additional Ps0,000, whereas conservative Plan B
horrowing only P50,000 and acquiring an additional P150,000 in stock withcalls for
24,000
shares.

In Figure 8-1 earnings per share are computed for the two plans at various levels
of earnings before interest and taxes (EBIT)". These
earnings (EBIT) represent
the operating income of the firm before deductions are made for interest
or taxes.
expense
172 Chapter 8

E BIT
PO EBIT
EBIT
Plan A P12,000 EBIT
Plan B Plan A P16,000
Levera Plan B Plan A P30,000
Conser- Levera- Plan B Plan A EBIT
ged vative
Conser- Levera- Plan B
ged vative Conser Levera- P50.000
Plan A
gea vative ged
Conser- Plan B
Earnings vative Levera-
before ged Conser
interest
vative
and taxes
(EBIT) P P
Less: P12.000 P12,000 P16.000 P16,000 P30.000 P30.000
Interest P50,000
12,000 4,000
12,000 P50.000
Earnings 4,000 12.000 4.000
before 12.000 4,000
12,000 4.000
taxes
(EBT) (12.000) (4.000)
Less: 8,000 4,000 12,000 18,000 26,000
Taxes 38,000 46,000
(50%) (6,000) (2.000) 0 4.000
Earnings 2.000 6,000 9,000 13,000 19,000 23.000
after
taxes
(EAT) (6.000) (2.000) P4,000 P 2.000
Shares 8,000 24.000 P6.000 P9.000 P13,000
8,000 24.000 P19,000 P23,000
Earnings 8,000 24.000 8,000 24,000 8.000 24,000
per share
(EPS) P (0.75) P (.08) P O P0.17
P25 P 25 P1.13 P.54 P 2.38 P 96
Figure 8-1. Computation of Earnings Per Share (EPS)
 Operating and Financiai
Leverage 173
It can bee hcerved from the results shown in
the same operating income, the
Figure 8-1 that although both
impact of the two plans
financing
assume

dent that the

It is evident the conservative plans is very
levels but the leveraged financial plan will produce better
substantial.
ow
results at low income
ner financial plan will generate higher
share as
earnings per sha operating income
EBIT goes
or
up. The firm would be
ifferent between the two plans at an EBIT level ofP16,000.

FINANCIAL LEVERAGE
pEGREE OF

The of financial leverage measures the effect of a change in one variable to

another variable. Degree of financial leverage (DFL) may be defined as the
entage change in earnings (EPS) that occurs as a result of a percentage change
perc
before interest and taxes (EBIT).
in earnings

Degree of financial leverage Percent change in EPS

Percent change in EBIT

Eor purposes of computation, the formula for DFL may be conveniently restated
as

Degree of financial leverage EBIT

EBIT-1

Let's compute the degree of financial leverage for Plan A and Plan B at an EBIT
level of P36,000. Plan A calls for P12,000 of interest at all levels of financing., and
Plan B requires P4,000.

Plan A (Leveraged)

DFL
EBIT
EBIT
1
P36,000 = P36,000 = 1.5
P36,000P12,000 P24,000

Plan B (Conservative)

DFL
EBIT P36,000 P36,000 = 1.1
EBIT 1 P36,000P4,000 P32,000

s expected, Plan A has a much higher degree of financial leverage. At an EBIT

O FS6,000, a l percent increase in earnings will produce a 1.5 percent
increase under
C S e in
earnings per share under Plan A, but only a 1.1 percent
 174 Chapter8
and it will change fromm
an B. DFL may be computed for any level of operation,
point to point, but Plan A will always exceed
Plan B.

LIMITATIONS TO USE OF FINANCIAL LEVERAGE

We may quickly observe that if debt is such a good thing, why sell any stock? With
exclusive debt financing at an EBIT level of P36,000, we would have agree of

financial leverage factor (DFL) of 1.8.

DFL =
EBIT P36,000 P36,000 = 1.8

EBIT- 1 P36,000-P16,000 P20,000

With no stock, we would borrow the full P200,000. (8% x P200,000 = P16,000

interest).
As stressed out throughout the text, debt financing and financial leverage offer
unique advantages, but only up to a point that debt financimg may be detrimental
to the firm. For example, as we expand the use of debt in our capital structure,
lenders will perceive a greater financial risk for the firm. For that reason, they may
raise the average interest rate to be paid and they may demand that certain
restrictions be placed on the corporation. Furthermore, concerned common
stockholders may drive down the price of the stock forcing us away from the
objective of maximizing the firm's overall value in the market. The impact of
financial leverage must be carefully weighed by firms with high debt.

COMBINING OPERATING AND FINANCIAL LEVERAGE

Degree of combined leverage (DCL) the entire income statement shows the
use
impact of a change in sales or volume on bottom-line earnings per share. Degree

of operating and financial leverage is in effect, being combined.

fim's sales go from
Figure 8-2 shows what happens to profitability as the
P160,000 (80,000 units) to P200,000 (100,000 units).
 perating and Financial Le uge 175
Sales (P2 per unit x
80,000 units)
Less: Fixed Costs
P160,000
Variable Cost (PO.80 60,000 P200,000
Operating income (EBIT)
per unit) 60,000
64,000 80,000
Less: Interest 36,000
60,000
Earnings before taxes 12,000 12.000
Less: Taxes 24,000
Earnings after taxes 12,000 48,000
Shares P 12,000 24,000
Earnings per share 8,000
P24,000
P 1.50 8,000
3.00
Figure 8-2. Combining Operating and Financial
Leverage
The formula for degree of combined leverage is stated
as:

Degree of combined leverage (DCL) = Percent change in EPS

Percent change in Sales
(or
volume)
Using data from Figure 8-2, the degree of combined
leverage is:
P1.50
Percent change in EPS P1.50 x 100
Percent change in Sales 100%
P 40,000 25%
= 4
P160,000 X 100

Every percentage point change in sales will be reflected in 4

earnings per share at this level of operation.
a
percent change in

The formula is:

Degree of combined leverage (DCL) =

QCP-VC)
Q(P- VC) - FC- 1
 176
Chapter 8
unit) P2.00; VC (variaki.
=

r o m Figure 8-2, Q (quantity) 80,000; P (price per

=

P60,000; and I (interest) =P12.000

P0.80: FC (fixed costs)
=

COsts per unit)

=

80,000 (P2.00 PO.80)

DCL
80,000(P2.00
12.000
PO.80) - P60,000- 12,000

80,000 (P1.20)
80.000 (PI.20) P72,000

P96,000
P96,000-P72,000

DCL P96,000 4
P24,000
 Operating and Financial Leverage 177
REVIEW QUESTIONS AND PROBLEMs

Q u e s t i o n s

What is meant by a product s contribution margin ratio? How is this ratio

1.
useful in planning business operations?

Often the most direct route to a business decision is an incremental

analysis. What is meant by an incremental analysis?2

3. What is meant by the term operating leverage?

4. What is meant by the term break-even point?

I n response to a request from your immediate supervisor, you have

prepared a CVP graph portray1ng the cost and revenue characteristics of
your company's product and operations. Explain how the lines on the
graph and the break-even point would change if (a) the selling price per
unit decreased, (b) fixed cost increased throughout the entire range of
activity portrayed on the graph, and (c) variable cost per unit increased.

6. What is meant by the margin of safety?

7. What is meant by the term sales mix? What assumption is usually made
concerning sales mix in CVP analysis?

8. Explain how a shift in the sales mix could result in both a higher break-
even point and a lower net income.

9. What factors would cause a difference in the use of financial leverage for
a utility
company and an automobile company?

10. Explain how the break-even point and operating leverage are affected by
the choice of
manufacturing facilities (labor intensive versus captal
intensive).
1. What role does depreciation play in break-even analysis based on
accounting flows? Based on cash flows? Which perspective is longer
term in nature?