Exam 10: Leverage and Capital Structure

The controversy over the existence of an optimal capital structure is debated between those_________who believe a traditional approach exists and those _________, who do not believe one exists. In the _________approach to capital structure, the optimal capital structure occurs where the_________is minimized.

With the existence of fixed operating costs, a decrease in sales will result in_________in EBIT.

A firm has EBIT of $375,000, interest expense of $75,000, preferred dividends of $6,000 and a tax rate of 40 percent. The firm's degree of financial leverage at a base EBIT level of $375,000 is_________.

Effective capital structure decisions can lower the cost of capital, resulting in higher NPVs and more acceptable projects, thereby increasing the value of the firm.

The optimal capital structure is the one that balances

If a firm's fixed operating costs decrease, the firm's operating break-even point will

Symmetric information results when managers of a firm have more information about operations and future prospects than do investors.

Total leverage is concerned with the relationship between the firm's sales revenue and its common stock earnings per share.

Generally, increases in leverage result in increased return and risk, whereas decreases in leverage result in decreased return and risk.

In general, low debt-payment ratios are associated with high degrees of financial leverage.

The conflict resulting from a manager's desire to increase the firm's risk without increasing currentborrowing costs and a lenders' desire to limit lending is one effect of the_________problem.

A firm has fixed operating costs of $150,000, total sales of $1,500,000, and total variable costs of$1,275,000. The firm's operating break-even point in dollars is___________ .

The steeper the slope of the capital structure line, the lower the financial risk.

A firm has an operating profit of $300,000, interest of $35,000, and a tax rate of 40 percent. The firm has an after-tax cost of debt of 5 percent and a cost of equity of 15 percent. The firm's target capital structure is set at a mix of 40 percent debt and 60 percent equity. According to the traditional approach to capital structure, the value of the firm is

Probability of bankruptcy is determined by

With the existence of fixed operating costs, an increase in sales will result in___________increase inEBIT.

One function of break-even analysis is to

The firm's ___________is the mix of long-term debt and equity utilized by the firm, which maysignificantly affect its value by affecting return and risk.

Operating leverage is present when a firm has fixed operating cost.

Earnings before interest and taxes is positive above the operating break-even point, and a loss occurs below it.