An entity with a higher proportion of fixed costs to variable costs compared to an entity with a lower proportion of fixed to variable costs is regarded as:

Question

BlackTom AI · Accepted Answer

A firm with a higher proportion of fixed costs exhibits greater operating leverage, so it is riskier.

1) Relevant knowledge points and concepts
- Fixed costs do not vary with output (e.g., rent, depreciation); variable costs do (e.g., materials, hourly wages).
- Degree of Operating Leverage (DOL) measures how sensitive operating income (EBIT) is to changes in sales: DOL ≈ Contribution Margin / Operating Income, or percent change in EBIT ÷ percent change in sales.
- Higher fixed-cost proportion → higher contribution margin required to cover fixed costs → larger DOL → greater variability of profits for a given sales change → higher business (operating) risk.

2) Complete reasoning process step by step
- Compare two otherwise identical entities at the same sales level: one with high fixed costs and low variable costs, the other with low fixed costs and high variable costs.
- Compute contribution margin and operating income for each, then compute DOL to see which has greater sensitivity of profit to sales changes.

3) Calculations with intermediate steps (numeric example)
- Assume both have sales = $1,000.
- High-fixed entity: Fixed = $500, Variable = $300 → Contribution margin = Sales − Variable = 1,000 − 300 = 700. Operating income = 700 − 500 = 200. DOL = 700 / 200 = 3.5.
- Low-fixed entity: Fixed = $200, Variable = $600 → Contribution margin = 1,000 − 600 = 400. Operating income = 400 − 200 = 200. DOL = 400 / 200 = 2.0.
- If sales rise 10%: High-fixed EBIT increases by 3.5 × 10% = 35% (200 → 270); Low-fixed EBIT increases by 2 × 10% = 20% (200 → 240). Conversely, a sales decline causes larger percentage drops in EBIT for the high-fixed firm.

4) Why the correct answer is correct
- The high fixed-cost firm has a larger DOL, so small changes in sales produce much larger swings in operating income. This greater variability in earnings translates directly into higher operating or business risk. Therefore an entity with a higher proportion of fixed to variable costs is riskier.

5) Why the other options are incorrect
- "having a lower operating leverage." Incorrect: higher fixed costs produce higher—not lower—operating leverage.
- "equal in risk." Incorrect: different cost structures yield different profit sensitivity, so risk is not equal.
- "less risky." Incorrect: higher fixed costs increase the volatility of profits, making the firm more risky, not less.

6) Conclusion
- The correct answer is "riskier." This matches the provided answer.

An entity with a higher proportion of fixed costs to variable costs compared to an entity with a lower proportion of fixed to variable costs is regarded as:单项选择题

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