Amalgamated Mining,Inc.has very high operating leverage due to the capital intensive nature of the steel business.The firm's CEO is concerned about the variability in the firm's EPS if sales should drop,and decides to take action.Which of the following will reduce the variability in the firm's EPS for a given change in sales?
A) The CEO may increase the firm's financial leverage and hence reduce the variability by using non-shareholder money to support the business.
B) The CEO may decrease the firm's financial leverage, thus lowering the firm's total leverage.
C) The CEO may increase the firm's total leverage by raising money from the sale of common stock.
D) The CEO may issue more corporate bonds and use the proceeds to pay off short-term liabilities.

Question

Quizplus · Accepted Answer

By decreasing the firm's financial leverage, the total leverage of the firm would decrease, thereby reducing the variability in EPS for a given change in sales. This is because a decrease in financial leverage would mean a decrease in interest expenses, which would help reduce the impact on EPS in case of a sales drop. The other options, such as increasing financial or total leverage, issuing more corporate bonds, or raising money from the sale of common stock, would not necessarily reduce the variability in EPS for a given change in sales.