Because the degree of total leverage is multiplicative and not additive, when a firm has very high operating leverage it can moderate its total risk by ________.
A) increasing sales
B) using a higher level of financial leverage
C) increasing EBIT
D) using a lower level of financial leverage

Question

Quizplus · Accepted Answer

Using a lower level of financial leverage can help a firm with high operating leverage moderate its total risk. High operating leverage means fixed costs are a large portion of total costs, making earnings more sensitive to changes in sales. Adding high financial leverage (more debt) would increase this sensitivity (risk) because of the fixed financial obligations. Lower financial leverage means fewer fixed financial obligations, thus moderating total risk.

Because the Degree of Total Leverage Is Multiplicative and Not