This article help us understand operating leverage, financial leverage, combined leverage, beta, risk free rate of return and better source of financing i.e debt or equity

Operating leverage
Consists of fixed costs rather than variable costs. Also, degree to
which firm can increase operating income by increasing revenue.
Cost of good sold 
Cost of goods sold (COGS) refers to the direct costs of producing the goods sold by a company. More sales, more Cost of good sold.

Operating leverage= FC/FC+VC. High operating leverage shows high amount of cost are fixed cost for that company. Operating income will be volatile depending hugely on sales

Positive Operating Leverage
When fixed cost has a greater portion in the total cost structure of the firm / company, a small percentage increase in sales increases a greater percentage in net operating income. This concept is known as positive operating leverage.

Negative Operating Leverage
A negative operating leverage is a situation where fixed cost has a greater portion in the total cost structure of the company and there is a decrease in sales. Such a situation has a negative effect on the revenue of the firm resulting in a greater percentage decrease in net operating income.

Financial leverage

Financial leverage is the use of borrowed money (debt) to finance the purchase of assets with the expectation that the income or capital gain from the new asset will exceed the cost of borrowing. 
The debt-to-equity ratio is used to determine the amount of financial leverage of an entity, and it shows the proportion of debt to the company's equity. It helps the company's management, lenders, shareholders, and other stakeholders understand the level of risk in the company's capital structure.
likelihood of the borrowing entity facing difficulties in meeting its debt obligations.
Volatility of Stock Price
Increased amounts of financial leverage may result in large swings in company profits. As a result, the company's stock price will rise and fall more frequently, and it will hinder the proper accounting of stock options owned by the company employees.

Combined leverage
Combined leverage (ol + fl) represents a company's total risk related to operating leverage, financial leverage, and the net effect on the eps. By calculating cl, finance managers can make more precise decisions with regards to the company's overall risk. Additionally, combined leverage can help managers identify any potential issues with the company's capital structure. 
The more a company's operations rely on borrowed money, the greater the risk of bankruptcy, if the business hits hard times. This is because minimum payments on loans must still be paid-even if a company has not profited enough to meet its obligations. For a highly leveraged company, sustained earnings declines could lead to financial distress or bankruptcy.
Lower the debt to equity ratio lower is combined leverage and less risky is company to invest in, as it doesn't rely on loans whose interest it has to pay, no matter how lower the profits they are earning.


Beta is a measure of the volatility or systematic risk of a security or portfolio compared to the market as a whole.

Adding a stock to a portfolio with a beta = 1.0 doesn't add any risk to the portfolio, but it also doesn't increase the likelihood that the portfolio will provide an excess return.

Beta < 1.0 means Including this stock in a portfolio makes it less risky than the same portfolio without the stock and less return expectations.

Beta > 1.0 shows security price is more volatile than market in whole.
This indicates that adding the stock to a portfolio will increase the portfolio's risk, but may also increase its expected return.

Risk free return is guaranteed rate of return with zero risk attached. 
Usually taken from government securities and bond's because it is commonly considered to equal to the interest paid on a 3-month government Treasury bill, generally the safest investment an investor can make.

Better source of financing, debt or equity
Debt is better as interest is deducted from earnings before paying income tax. So, debt financing comes without income tax.
While in equity there isn't anything like interest, we do have dividend but income tax is charged on earnings in whole on equity financing.
EBT is more in equity financing than debt.


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