Exam 10: Leverage and Capital Structure

Optimal capital structure is the capital structure at which the weighted average cost of capital is minimized, thereby maximizing the firm's value.

A firm is analyzing two possible capital structures-30 and 50 percent debt ratios. The firm has totalassets of $5,000,000 and common stock valued at $50 per share. The firm has a marginal tax rate of40 percent on ordinary income. The number of common shares outstanding for each of the capital structures would be

A corporation has $5,000,000 in 10 percent bonds and $3,000,000 in 12 percent preferred stockoutstanding. The firm's financial break-even (assuming a 40 percent tax rate) is __________.

Hammel Corporation is comparing two different capital structures, an all-equity plan and alevered plan. Under the all-equity plan, Hammel would have 80,000 shares of stock outstanding.Under the levered plan, there would be 50,000 shares outstanding and $300,000 in debtoutstanding. A share of stock is valued to be $10 regardless of the plan. The interest rate on the debt is 8%. Ignoring taxes, at EBIT equal to $100,000, shareholders of Hammel Corporation would

Which of the following is NOT a reason why debt capital is considered to be the least risky source of capital?

The use of a dollar break-even point is important when a firm has more than one product, especially when each product is selling at a different price.

Because the degree of total leverage is multiplicative and not additive, when a firm has very high operating leverage it can moderate its total risk by

A decrease in fixed operating costs will result in__________in the degree of financial leverage

A decrease in fixed financial costs will result in___________in financial risk

In general, the greater the firm's operating leverage, the higher its business risk.

As debt is substituted for equity in the capital structure and the debt ratio increases, all of thefollowing statements about the component costs of capital are true EXCEPT

An increase in cost (fixed cost or variable cost) tends to increase the operating break-even point, whereas an increase in the sales price per unit will decrease the operating break-even point.

The basic sources of capital for a firm include all of the following EXCEPT

Due to the difficulty of allocating costs to products in a multiproduct firm, the break-even model may fail to determine break-even points for each product line.

The EBIT-EPS analysis tends to concentrate on maximization of earnings rather than maximization of owners' wealth.

The higher financial leverage causes_________to increase more for a given increase in_________

Business risk is the risk to the firm of being unable to cover operating costs.

_________leverage is concerned with the relationship between earnings before interest and taxes and earnings per share.

Financial leverage results from the presence of variable financial costs in the firm's income stream.

The cost of equity increases with increasing financial leverage in order to compensate the stockholders for the higher degree of financial risk.