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Chapter 12
Guillermo Giorgis MA2N0227
Operating leverage
 The
potential use of fixed operating
costs to magnify the effects of
changes in sale on the firm’s earnings
before interest and taxes (EBIT)
Earnings before interest and taxes : EBIT
Sale revenue – Variable operating costs – Fixed operating costs = EBIT
P= sale price per unit
Q=Sale quantity in units
FC=Fixed operating cost per period
VC=variable operating cost per unit
Measuring the degree of operating
leverage (DOL)
DOL =
percentage change in EBIT
𝑄×(𝑃−𝑉𝐶)
=
Percentage change in sales 𝑄× 𝑃−𝑉𝐶 −𝐹𝐶
Adobe’s leverage
The up-front development costs are fixed
production costs are approximately zero
(Variable operation cost = 0)
The economies of scale are huge
 Once
a company sells enough copies to
cover its fixed costs, incremental dollars go
primarily to profit
 Because
the company has no long-term
debt in it’s capital structure
 It’s
total leverage is derived only from FC
What might cause the gradual decrease in
operating leverage for Adobe?
Item
FY2002
FY2003
FY2004
$1165
$1295
$1666
$1966
$2575
285
380
608
766
678
(1)% change in sales
-5.3%
11.2%
28.6%
18.0%
31.0%
(2)% change in EBIT
-24.6%
33.3%
60.0%
26%
-11.5%
4.6
3.0
2.1
1.4
-0.4
Sales revenue
(millions)
EBIT (million)
DOL (2÷1)
DOL =
FY2005
FY2006
percentage change in EBIT
𝑄×(𝑃−𝑉𝐶)
=
Percentage change in sales 𝑄× 𝑃−𝑉𝐶 −𝐹𝐶
The acquisition of Macromedia for
approximately 3.5 billion on December 2005
They have a huge fixed cost on December 2005 that
influence on the Operating leverage (decrease) in 2006
DOL =
percentage change in EBIT
𝑄×(𝑃−𝑉𝐶)
=
Percentage change in sales 𝑄× 𝑃−𝑉𝐶 −𝐹𝐶
Answer
 Changes
fixed cost is the cause of the
gradual decrease in operating leverage
for Adobe