Types of Leverage: Financial, Operating and Combined - Essay Example

Depending on the type of industry a company is a part of their degree of leverage varies greatly throughout their life cycle. There are two types of leverage; financial and operating leverage. Companies with high levels of fixed costs are said to have a high degree of operating leverage. For a business, a high degree operating leverage maintaining other factors constant means that a small change in sales will result in a large change in operating income. The main sources of operating leverage come from rent, utilities, depreciation, inventory levels, selling and administrative expenses ,and of course the monthly allocations for loan and interest payments.

The degree of financial leverage affects the expected return for the stockholders, since the level of financing has a direct return on EPS (Besley & Brigham, 2000). The firm can enter in a variety of financing agreements such short or long term loan agreements, working capital loans, and bonds which are some of the sources of financial leverage.For our non-profit organization raffle the organization was considering hiring a professional fundraiser to help sell the tickets to our esteemed contributors, friends and partners, after analyzing a cost/benefit analysis we consider that the fixed fee of $10,000 for the professional fundraising specialist, makes the project unreasonably risky for our organization.

The problem lies in the fact that out of the 5,000 individuals in our list, the company would have to sell 2,200 tickets just to break even. This figure already corresponds to a 44% participation rate. In general terms the typical response rates are less than 35%, so we can safely assume that even though we possess quality leads, it would be unrealistic to expect a positive revenue flow out of this project based on the high fixed costs associated with hiring a professional fundraiser. In our honest opinion the only way to make this project feasible would be to enlist the greatest number of volunteers and provide them with a half day training session covering the best practices for fundraising techniques and prepare a well written sales script in order to help them with the lead calling process.

We can conclude that the small scope of the project a professional fundraising company would be impractical since the ROI would most likely be negative, consequently making the initiative unfeasible.When comparing the steel industry versus a donut shop, one immediately notices that their level of fixed costs and financial leverage are going to be very different indeed. Without a doubt a steel company with multimillion dollars investment on plant, machinery and equipment would have much higher fixed costs that a donut shop which probably invested a few hundred thousand in setting up their production line.

Therefore the steel mill will definitely have a significantly higher degree of operating leverage compared with the donut factory. Their degree of financial leverage is a little harder to predict, but in general one can safely assume that due to the high degree of initial investment, the steel company would take advantage of obtaining financing to cover most of the investment in the initial phase of the project. A donut shop can make probably make due with a relatively small amount financing, since this type of businesses are typically started with an initial cash outlay by the investors, sometimes combined with a certain level of financing which is usually highly dependent on the owners personal equity, and credit.

Therefore we can conclude that the degree of financial leverage would probably also be higher for a steel company compared with a donut shop.ReferencesBesley, S., Brigham, E. (2000). Essential of Managerial Finance (12th ed.). Fort Forth: The Dryden Press.