Question

ATech has fixed costs of $7 million and profits of $4 million. Its competitor, ZTech, is roughly the same size and this year earned the same profits, $4 million. But it operates with higher fixed costs of $8 million and lower variable costs.
a. Which firm has higher operating leverage
b. Which firm will likely have higher profits if the economy strengthens?

Answer 1

Answer:

a. ZTech will have a higher operating leverage because it has a higher fixed cost.

b. ZTech will have a higher profit since it has a higher operating leverage if the economy strengthens.

Explanation:

Operating leverage measures the the extent to which a firm uses fixed cost to finance its operations. The higher the fixed cost, the higher the degree of operating leverage

If the economy strengthens, the firm with a higher degree of operating leverage earns a higher profit.