Relationship betn Operating leverage and Beta

[VrindaC]

Chapter 18 page 8
In the box, it is stated that high operating leverage implies higher beta should be used. How can high proportion of FIXED costs increase systematic risk?? Why would the returns be more volatile? Infact variable cost should make the returns more volatile right?

 

[Rajat gupta]

Chapter 18 page 8
In the box, it is stated that high operating leverage implies higher beta should be used. How can high proportion of FIXED costs increase systematic risk?? Why would the returns be more volatile? Infact variable cost should make the returns more volatile right?

I think this is because higher fixed cost curb flexibility for the company then the variable cost. They are a fixed burden and role is similar to rising gearing in a financial leverage. So rising operating leverage result in higher systematic risk and rising of beta

 

[Colin McKee]

Yes - fixed costs increase your risk as you cannot reduce them when times are bad. Variable doesnt mean "uncertain" - it means that they rise with increasing turnover, and fall with falling turnover.

 

[VrindaC]

Thanks!!