Question 1

Which of the following is not true about leverage?

Accepted Answer

A)  Operating leverage influences the top half of the income statement,determining EBIT. 
B)  Financial leverage deals with the bottom half of the income statement,determining EPS. 
C)  Combined leverage utilizes the entire income statement,showing the impact of change in volume on EBIT. 
D)  Combined leverage utilizes the percentage change in EPS and percentage change in sales. 
A)  Operating leverage influences the top half of the income statement,determining EBIT. 
B)  Financial leverage deals with the bottom half of the income statement,determining EPS. 
C)  Combined leverage utilizes the entire income statement,showing the impact of change in volume on EBIT. 
D)  Combined leverage utilizes the percentage change in EPS and percentage change in sales. C

Question 2

A new restaurant is ready to open for business.It is estimated that the food cost (variable cost)will be 40% of sales,while fixed cost will be $450,000.The first year's sales estimates are $1,250,000.The cost to start up this restaurant will be $2,000,000.Two financing alternatives are being considered: (a)50% equity financing and 50% debt at 12%,or (b)all equity financing.Common stock can be sold at $5 per share.
A)Compute break-even point.
B)Compute DOL.
C)Compute DFL and DCL for both financing plans.
D)Include an explanation of what your computations mean.
A)   B) $$\begin{array} { l } 
D O L = \frac { S - T V C } { S - T V C - F C } = \frac { \$ 1,250,000 - 0.40 ( \$ 1,250,000 ) } { \$ 1,250,000 - 0.40 ( \$ 1,250,000 ) - \$ 450,000 } \
D O L = \frac { \$ 750,000 } { \$ 300,000 } = 2.50 \times
\end{array}$$ C) $$D F L = \frac { E B I T } { E B I T - I } = \frac { \$ 300,000 } { \$ 300,000 - \$ 120,000 } = 1.67 \times$$ $$D C L = \frac { S - T V C } { E B I T - I } = \frac { \$ 750,000 } { \$ 180,000 } = 4.17 \times = 2.50 \times 1.67$$ $$D F L = \frac { E B I T } { E B I T - I } = \frac { \$ 300,000 } { \$ 300,000 - \$ 0 } = 1.00 \times$$ $$D C L = \frac { S - T V C } { E B I T - I } = \frac { \$ 750,000 } { \$ 300,000 } = 2.50 \times = 2.50 \times 1.00$$ D)Subjective.

Accepted Answer

A)$\begin{array} { l l l } 
\text { Break-even point in sales } & \text { Sales } & = \text { Variable Cost } + \text { Fixed Cost } \
& \text { Sales } & = 0.40 \text { Sales } + \$ 450,000 \
& 0.60 \text { Sales } & = \$ 450,000 \
& \text { Sales } & = \$ 750,000
\end{array}$
B)$$\begin{array} { l } 
D O L = \frac { S - T V C } { S - T V C - F C } = \frac { \$ 1,250,000 - 0.40 ( \$ 1,250,000 ) } { \$ 1,250,000 - 0.40 ( \$ 1,250,000 ) - \$ 450,000 } \
D O L = \frac { \$ 750,000 } { \$ 300,000 } = 2.50 \times
\end{array}$$
C) PLAN A $$D F L = \frac { E B I T } { E B I T - I } = \frac { \$ 300,000 } { \$ 300,000 - \$ 120,000 } = 1.67 \times$$
$$D C L = \frac { S - T V C } { E B I T - I } = \frac { \$ 750,000 } { \$ 180,000 } = 4.17 \times = 2.50 \times 1.67$$
PLAN B
$$D F L = \frac { E B I T } { E B I T - I } = \frac { \$ 300,000 } { \$ 300,000 - \$ 0 } = 1.00 \times$$
$$D C L = \frac { S - T V C } { E B I T - I } = \frac { \$ 750,000 } { \$ 300,000 } = 2.50 \times = 2.50 \times 1.00$$
D) Subjective.

Question 3

If the contribution margin on the firm's single product is $2.00 per unit and fixed costs are $60,000,what will the firm's net income be at sales of 30,000 units?

Accepted Answer

A)  $90,000 
B)  $30,000 
C)  $15,000 
D)  $0 
A)  $90,000 
B)  $30,000 
C)  $15,000 
D)  $0 D

Question 4

In break-even analysis the contribution margin is defined as:

Accepted Answer

A)  sales minus variable costs. 
B)  sales minus fixed costs. 
C)  fixed costs minus variable costs. 
D)  fixed costs minus amortization. 
A)  sales minus variable costs. 
B)  sales minus fixed costs. 
C)  fixed costs minus variable costs. 
D)  fixed costs minus amortization.

Question 5

Which of the following is concerned with the change in operating profit as a result of a change in volume?

Accepted Answer

A)  Financial leverage 
B)  Break-even point 
C)  Operating leverage 
D)  Combined leverage 
A)  Financial leverage 
B)  Break-even point 
C)  Operating leverage 
D)  Combined leverage

Question 6

$\begin{array}{lr}
\text { Sales }(75,000 \text { units }) & \$ 750,000 \
\text { Variable costs } & \underline{225,000} \
\text { Contribution margin } & 525,000 \
\text { Fixed manufacturing costs } & \underline{187,500}\
\text { Operating income } & 337,500 \
\text { Interest } & \mathbf{7 5 , 0 0 0} \
\text { Earnings before taxes } & 262,500 \
\text { Taxes (at } 31 \% \text { ) } & 81.375\
\text { Net income }&\$181,125\
\text { Shares outstanding }&15,000
\end{array}$
-The Degree of Combined Leverage is:

Accepted Answer

A)  2.1x. 
B)  1.9x. 
C)  2.9x. 
D)  2.0x. 
A)  2.1x. 
B)  1.9x. 
C)  2.9x. 
D)  2.0x.

Question 7

Raw materials used in the manufacturing process are generally classified as fixed costs.In contrast,property taxes are classified as variable costs.

Accepted Answer

A) True 
 B)False

Question 8

Operating leverage primarily affects the left hand side of the balance sheet while financial leverage affects the right hand side of the balance sheet.

Accepted Answer

A) True 
 B)False

Question 9

Operating Leverage works best when volume is increasing.

Accepted Answer

A) True 
 B)False

Question 10

Operating leverage influences the bottom half of the income statement while financial leverage deals with the top half.

Accepted Answer

A) True 
 B)False

Question 11

Operating leverage determines how income from operations is to be divided between debt holders and shareholders.

Accepted Answer

A) True 
 B)False

Question 12

Heavy use of long-term debt may be detrimental in a deflationary economy because:

Accepted Answer

A)  the debt may be repaid in more "expensive" dollars. 
B)  nominal interest rates exceed real interest rates. 
C)  inflation is associated with the peak of a business cycle. 
D)  the debt may be repaid in "cheaper" dollars. 
A)  the debt may be repaid in more "expensive" dollars. 
B)  nominal interest rates exceed real interest rates. 
C)  inflation is associated with the peak of a business cycle. 
D)  the debt may be repaid in "cheaper" dollars.

Question 13

Operating income is not the same thing as EBIT.

Accepted Answer

A) True 
 B)False

Question 14

If a firm has a DFL of 2.0,EPS will change 2% for every 1% change in volume.

Accepted Answer

A) True 
 B)False

Question 15

A firm with a high degree of financial leverage could face financial difficulty even though it is in a stable industry.

Accepted Answer

A) True 
 B)False

Question 16

The degree of financial leverage measures the percentage change in EPS for every 1 percent move in EBIT.

Accepted Answer

A) True 
 B)False

Question 17

Financial leverage is concerned with the relation between:

Accepted Answer

A)  changes in volume and changes in EPS. 
B)  changes in volume and changes in EBIT. 
C)  changes in EBIT and changes in EPS. 
D)  changes in EBIT and changes in operating income. 
A)  changes in volume and changes in EPS. 
B)  changes in volume and changes in EBIT. 
C)  changes in EBIT and changes in EPS. 
D)  changes in EBIT and changes in operating income.

Question 18

Financial leverage primarily affects the _________ while operating leverage primarily affects the __________.

Accepted Answer

A)  left-hand side of the balance sheet; the right-hand side of the balance sheet 
B)  right-hand side of the balance sheet; the upper part of the income statement 
C)  lower part of the income statement; the right-hand side of the balance sheet 
D)  the upper part of the income statement; the left-hand side of the balance sheet 
A)  left-hand side of the balance sheet; the right-hand side of the balance sheet 
B)  right-hand side of the balance sheet; the upper part of the income statement 
C)  lower part of the income statement; the right-hand side of the balance sheet 
D)  the upper part of the income statement; the left-hand side of the balance sheet

Question 19

Explain the implications of your answers if the machine shop business is highly cyclical.

Accepted Answer

As the amount of lev

Question 20

$$\begin{array} { l r } 
\text { Sales } ( 100,000 \text { units) } & \$ 1,000,000 \
\text { Variable costs } & \underline { 300,000 } \
\text { Contribution margin } & 700,000 \
\text { Fixed manufacturing costs } & \underline { 250,000 } \
\text { Operating income } & 450,000 \
\text { Interest } & \underline { 60,000 } \
\text { Earnings before taxes } & 390,000 \
\text { Taxes (at } 31 \% \text { ) } & \underline { 120,900 } \
\text { Net Income } & \underline { \$ 269,100 } \
\text { Shares outstanding } & 10,000
\end{array}$$
-The Degree of Operating Leverage is:

Accepted Answer

A)  1.79x. 
B)  1.56x. 
C)  2.22x. 
D)  2.33x. 
A)  1.79x. 
B)  1.56x. 
C)  2.22x. 
D)  2.33x.

Which of the following is not true about leverage?

If the contribution margin on the firm's single product is $2.00 per unit and fixed costs are $60,000,what will the firm's net income be at sales of 30,000 units?

In break-even analysis the contribution margin is defined as:

Which of the following is concerned with the change in operating profit as a result of a change in volume?

Sales (75,000 units ) \ 750,000 Variable costs Contribution margin 525,000 Fixed manufacturing costs Operating income 337,500 Interest Earnings before taxes 262,500 Taxes (at 31\% ) 81.375 Net income \1 81,125 Shares outstanding 15,000 -The Degree of Combined Leverage is:

Raw materials used in the manufacturing process are generally classified as fixed costs.In contrast,property taxes are classified as variable costs.

Operating leverage primarily affects the left hand side of the balance sheet while financial leverage affects the right hand side of the balance sheet.

Operating Leverage works best when volume is increasing.

Operating leverage influences the bottom half of the income statement while financial leverage deals with the top half.

Operating leverage determines how income from operations is to be divided between debt holders and shareholders.

Heavy use of long-term debt may be detrimental in a deflationary economy because:

Operating income is not the same thing as EBIT.

If a firm has a DFL of 2.0,EPS will change 2% for every 1% change in volume.

A firm with a high degree of financial leverage could face financial difficulty even though it is in a stable industry.

The degree of financial leverage measures the percentage change in EPS for every 1 percent move in EBIT.

Financial leverage is concerned with the relation between:

Financial leverage primarily affects the _ while operating leverage primarily affects the __.

Explain the implications of your answers if the machine shop business is highly cyclical.

Sales (100,000 units) \ 1,000,000 Variable costs Contribution margin 700,000 Fixed manufacturing costs Operating income 450,000 Interest Earnings before taxes 390,000 Taxes (at 31\% ) Net Income Shares outstanding 10,000 -The Degree of Operating Leverage is:

The Goals and Activities of Financial Management

Review of Accounting

Financial Analysis

Financial Forecasting

Working Capital and the Financing Decision

Current Asset Management

Sources of Short-Term Financing

The Time Value of Money

Valuation and Rates of Return

Cost of Capital

The Capital Budgeting Decision

Risk and Capital Budgeting

Capital Markets

Investment Banking: Public and Private Placement

Long-Term Debt and Lease Financing

Common and Preferred Stock Financing

Dividend Policy and Retained Earnings

Convertibles, Warrants and Derivatives

External Growth Through Mergers

International Financial Management

Filters

Exam 5: Operating and Financial Leverage

Which of the following is not true about leverage?

If the contribution margin on the firm's single product is $2.00 per unit and fixed costs are $60,000,what will the firm's net income be at sales of 30,000 units?

In break-even analysis the contribution margin is defined as:

Which of the following is concerned with the change in operating profit as a result of a change in volume?

Sales (75,000 units ) \ 750,000 Variable costs Contribution margin 525,000 Fixed manufacturing costs Operating income 337,500 Interest Earnings before taxes 262,500 Taxes (at 31\% ) 81.375 Net income \1 81,125 Shares outstanding 15,000 -The Degree of Combined Leverage is:

Raw materials used in the manufacturing process are generally classified as fixed costs.In contrast,property taxes are classified as variable costs.

Operating leverage primarily affects the left hand side of the balance sheet while financial leverage affects the right hand side of the balance sheet.

Operating Leverage works best when volume is increasing.

Operating leverage influences the bottom half of the income statement while financial leverage deals with the top half.

Operating leverage determines how income from operations is to be divided between debt holders and shareholders.

Heavy use of long-term debt may be detrimental in a deflationary economy because:

Operating income is not the same thing as EBIT.

If a firm has a DFL of 2.0,EPS will change 2% for every 1% change in volume.

A firm with a high degree of financial leverage could face financial difficulty even though it is in a stable industry.

The degree of financial leverage measures the percentage change in EPS for every 1 percent move in EBIT.

Financial leverage is concerned with the relation between:

Financial leverage primarily affects the _________ while operating leverage primarily affects the __________.

Explain the implications of your answers if the machine shop business is highly cyclical.

Sales (100,000 units) \ 1,000,000 Variable costs Contribution margin 700,000 Fixed manufacturing costs Operating income 450,000 Interest Earnings before taxes 390,000 Taxes (at 31\% ) Net Income Shares outstanding 10,000 -The Degree of Operating Leverage is:

The Goals and Activities of Financial Management

Review of Accounting

Financial Analysis

Financial Forecasting

Working Capital and the Financing Decision

Current Asset Management

Sources of Short-Term Financing

The Time Value of Money

Valuation and Rates of Return

Cost of Capital

The Capital Budgeting Decision

Risk and Capital Budgeting

Capital Markets

Investment Banking: Public and Private Placement

Long-Term Debt and Lease Financing

Common and Preferred Stock Financing

Dividend Policy and Retained Earnings

Convertibles, Warrants and Derivatives

External Growth Through Mergers

International Financial Management

Filters

Financial leverage primarily affects the _ while operating leverage primarily affects the __.