Which of the following statements about Operating Leverage and Risk from the lecture are TRUE:Someone with relatively low fixed costs and high variable costs will have a high level of operating leverage and a high risk of making a large loss if their income falls.Someone with relatively high fixed costs and low variable costs will have a low level of operating leverage and a low risk of making a large loss if their income falls.Question 10AnswerNeither of the statements are true (both are false)Only statement 1 is trueOnly statement 2 is trueBoth statements are true (neither are false)
Question
Which of the following statements about Operating Leverage and Risk from the lecture are TRUE:Someone with relatively low fixed costs and high variable costs will have a high level of operating leverage and a high risk of making a large loss if their income falls.Someone with relatively high fixed costs and low variable costs will have a low level of operating leverage and a low risk of making a large loss if their income falls.Question 10AnswerNeither of the statements are true (both are false)Only statement 1 is trueOnly statement 2 is trueBoth statements are true (neither are false)
Solution 1
Only statement 1 is true.
Here's why:
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Operating leverage refers to the proportion of fixed costs to variable costs. A business with high fixed costs and low variable costs has high operating leverage. This means that a small change in sales volume can lead to a large change in operating income, increasing the risk of making a large loss if their income falls. So, the first statement is true.
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The second statement is incorrect because it contradicts the definition of operating leverage. A business with high fixed costs and low variable costs will have a high level of operating leverage, not a low one. Therefore, they also have a high risk of making a large loss if their income falls, not a low risk.
Solution 2
Only statement 1 is true.
Here's why:
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Operating leverage refers to the proportion of fixed costs to variable costs in a company's cost structure. A company with high fixed costs (like rent, salaries, etc.) and low variable costs (like raw materials, direct labor, etc.) will have a high level of operating leverage. This is because fixed costs must be paid regardless of the level of output, so if income falls, the company still has to cover these costs, leading to a higher risk of making a large loss.
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The second statement is incorrect because it suggests the opposite of the first. A company with high fixed costs and low variable costs will have a high, not low, level of operating leverage and a high, not low, risk of making a large loss if their income falls.
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