Exam 10: Leverage and Capital Structure

A firm has a current capital structure consisting of $400,000 of 12 percent annual interest debt and50,000 shares of common stock. The firm's tax rate is 40 percent on ordinary income. If the EBIT isexpected to be $200,000, two EBIT-EPS coordinates for the firm's existing capital structure are

_________analysis is a technique used to assess the returns associated with various cost structures and levels of sales.

Through the effects of financial leverage, when EBIT increases, earnings per share will

The EBIT-EPS approach to capital structure involves selecting the capital structure that maximizes earnings before interest and taxes (EBIT) over the expected range of earnings per share (EPS).

According to the traditional approach to capital structure, the value of the firm will be maximized when

The major shortcoming of the EBIT-EPS approach to capital structure is that

The closer the base sales level used is to the operating break-even point, the smaller the operating leverage.

The effect of financial leverage is such that an increase in the firm's earnings before interest and taxes (EBIT) results in a more than proportional increase in the firm's earnings per share (EPS), while a decrease in the firm's EBIT results in a less than proportional decrease in EPS.

The basic shortcoming of the EBIT-EPS approach to capital structure is

Because risk premiums increase with increases in financial leverage, the maximization of EPS does not assure owners' wealth maximization.

A firm's operating break-even point is sensitive to all of the following variables EXCEPT

The key differences between debt and equity capital include all of the following EXCEPT

Operating leverage may be defined as the potential use of fixed operating costs to magnify the effects of changes in sales on the firm's earnings before interest and taxes (EBIT).

At the operating break-even point,_________equals zero.

At a base sales level of $400,000, a firm has a degree of operating leverage of 2 and a degree offinancial leverage of 1.5. The firm's degree of total leverage is ____________.

In the EBIT-EPS approach to capital structure, risk is represented by

The relative inexpensive nature of debt capital is due to the fact that the lenders take the least risk of any long-term contributors of capital.

All items on the right-hand side of the firm's balance sheet, excluding current liabilities are called capital.

The cash break-even point is used when certain noncash charges, such as depreciation, constitutean important portion of the firm's fixed operating costs.

The lower risk nature of long-term debt in a firm's capital structure is due to the fact that