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Yes Sir I have watched the lectures, but sir what is confusing me is that as the question says that if for a given level of activity firms ratio of variable cost to fixed cost were to fall,what would be effect on firms operating risk.
So here the ratio of VC to FC would only fall under 2 conditions na i.e either VC decreases or FC increases. In both of these cases the operating gearing ratio will fall as operating gearing is directly proportional to VC and inversely proportional to FC. Am, I right?
So accordingly if operating gearing ratio falls then operating risk would ultimately fall but in the answer the operating risk increases, so I could not get this thing.
Or is it such that in operating gearing we just have to remember if FC increases then operating gearing will increase and if FC decreases then operating gearing will fall?
All the matters is whether fixed costs increase relative to variable costs. If they do then the operating gearing is increasing – there is more risk.
If fixed costs increase relative to variable costs, then the ratio of FC to VC will be higher, and the ratio of VC to FC will be lower – in both cases we say that the operating gearing is higher. (We are not saying that the number resulting is higher or lower – that is not what matters – we are saying that the gearing is higher.)
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