Gauging the success of a company usually involves some assessment of the firm’s earnings. When evaluating earnings, investors should consider the quality and sources of the company’s earnings, as well as their amount. In other words, the source of the earnings is as important a consideration as the size of the earnings.

Your team should discuss and then respond to the following questions. All team members should agree with and understand the answers (including the calculations supporting the answers) and be prepared to report in class. Each teammate can assume responsibility for a different part of the presentation.

Required:

1. Discuss the differences between operating profits and the bottom line—profits after all revenues and expenses.

2. Do you think a dollar of earnings coming from operations is any more or less valuable than a dollar of earnings generated from some other source below operating profits (e.g., one-time gains from selling assets or one-time writeoffs for charges related to closing a plant)? Explain.

3. What is the concept of operating leverage? What is the relation between operating leverage and operating profits?

4. What is the concept of financial leverage? What is the relation between financial leverage and return on common shareholders’ equity?