CA Inter P6 · Chapter 6 · Question 9 of 9
A firm with a high degree of operating leverage and a high degree of financial leverage is best described as:
Test yourself: pick an answer
Reveal answer & explanation
Correct answer: A) Very risky, because a small fall in sales can cause a sharp fall in EPS
Explanation
Combined leverage is DOL x DFL, so a high value of both multiplies the effect of a change in sales on EPS. This raises total risk: a small decline in sales can wipe out earnings for equity holders. Firms usually balance a high operating leverage with a low financial leverage, or the reverse.
More Financing Decisions – Leverages MCQs
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