Which company is considered riskier due to higher operating leverage, given similar revenues?

Which company is considered riskier due to higher operating leverage, given similar revenues?

• A. An airline with higher fixed costs
• B. A trucking company with more variable costs
• C. A retail chain with low fixed costs
• D. A technology company with high profit margins

Answer: (A)

The company considered riskier due to higher operating leverage is the airline with higher fixed costs. Operating leverage is a measure of how revenue growth translates into growth in operating income, influenced heavily by the proportion of fixed costs in the cost structure. In the context of an airline, fixed costs are significant, including expenses for equipment, leasing, maintenance, and salaries. Because these costs do not change with the volume of flights or passengers, any fluctuations in revenue can lead to substantial changes in profitability. If the airline experiences a drop in revenue, it still has to cover these fixed costs, which can lead to greater losses compared to a company with lower fixed costs. In contrast, a trucking company with more variable costs can adjust its expenses more easily in response to changes in revenue, reducing risk. Similarly, a retail chain with low fixed costs and a technology company with high profit margins generally have more flexibility and lower risk exposure because they are not as heavily burdened by fixed expenses. Thus, even with similar revenues, the airline's operating structure makes it riskier due to its higher operating leverage.

The company considered riskier due to higher operating leverage is the airline with higher fixed costs. Operating leverage is a measure of how revenue growth translates into growth in operating income, influenced heavily by the proportion of fixed costs in the cost structure.

In the context of an airline, fixed costs are significant, including expenses for equipment, leasing, maintenance, and salaries. Because these costs do not change with the volume of flights or passengers, any fluctuations in revenue can lead to substantial changes in profitability. If the airline experiences a drop in revenue, it still has to cover these fixed costs, which can lead to greater losses compared to a company with lower fixed costs.

In contrast, a trucking company with more variable costs can adjust its expenses more easily in response to changes in revenue, reducing risk. Similarly, a retail chain with low fixed costs and a technology company with high profit margins generally have more flexibility and lower risk exposure because they are not as heavily burdened by fixed expenses. Thus, even with similar revenues, the airline's operating structure makes it riskier due to its higher operating leverage.