Powerline Network Corporation (PNC) plans to spin off its wholly own subsidiary, PNC Router Inc. PNC created PNC Router to support its customers who did not want to use standard routers for their internal network. Router faces two strategic financial plans, Plan L and Plan H. If Router adopts Plan H, it would support future growth of the company. This plan would have higher fixed costs but lower variable cost per unit. On the other hand, Plan L allows the company to remain its current no-growth business strategy. If Plan L is adopted, the company would have low fixed costs with the outsourcing strategy. PNC must determine the correct strategic approach among these two plans. Several issues the team need to address comprising business risk,…show more content… Analysis
Q1- Define the terms operating and financial leverage as well as business and financial risk. Identify some factors that affect each of them and how they combine to affect the firm’s investment risk.
Operating leverage is a measurement of the degree to which a firm or project incurs a combination of fixed and variable costs (Operating Leverage, 2017). A high degree of operating leverage has the ability to negatively affect the potential danger of forecasting risk; a small error can become larger. Additionally, financial leverage is the degree to which a company uses fixed-income securities such as debt and preferred equity (Financial Leverage, 2017). A high degree of financial leveraging goes hand in hand with the amount of debt financing a company utilizes.
Furthermore, business risk is the possibility a company will have lower than anticipated profits or experience a loss rather than taking a profit (Business Risk, 2015). Business risk is affected by several factors including competition, input costs, sales volume, economic changes and government regulations. In addition to operating leverage, financial leverage and business risk, financial risk must also be considered. Financial risk is the possibility that shareholders will lose money when they invest in a company that has debt, if the company's cash flow proves inadequate to meet its financial obligations (Financial Risk, 2004). A firm that operates