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CFA Level I · CFA Level I Exam · Introduction to Equity Valuation

An analyst forecasts that a retailer's operating profit margin will improve because a growing share of its costs is fixed. This forecast is most consistent with the retailer having:

A margin that improves as sales grow because many costs are fixed reflects high operating leverage. Fixed costs are spread over more revenue, so operating profit rises faster than sales. Financial leverage concerns debt and interest, and a falling gross margin would reduce, not raise, profitability.

  1. Ahigh operating leverageCorrect
  2. Blow financial leverage
  3. Ca declining gross margin

Explanation

When many costs are fixed, additional sales raise revenue without a proportional rise in costs, so operating margin expands as sales grow. That is high operating leverage. Financial leverage relates to interest costs below operating profit, and a declining gross margin would work against margin improvement.

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