Exam 5: Operating and Financial Leverage

If a firm has a price of $4.00,variable cost per unit of $2.50,and a break-even point of 20,000 units,fixed costs are equal to:

Operating leverage primarily affects the __________ while financial leverage primarily affects the __________.

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 Financial Leverage is:

Operating Leverage is the use of fixed costs to magnify returns at high levels of operation.

The degree of combined leverage is the sum of the degree of operating leverage and the degree of financial leverage.

Greater leverage can be used by firms in periods of strong economic growth?

Doug Robinson is considering the possibility of opening his own manufacturing facility. He expects first-year sales to be $800,000, and he feels that his variable costs will be approximately 40% of sales. His fixed costs in the first year will be $200,000. Doug is considering two ways of financing the firm: (a) 40% equity financing and 60% debt at 10%, or (b) 100% equity financing. He can sell common stock to his relatives for $10 per share. Either way, he will need to raise $1,000,000. -Compute his break-even point in dollars.

Doug Robinson is considering the possibility of opening his own manufacturing facility. He expects first-year sales to be $800,000, and he feels that his variable costs will be approximately 40% of sales. His fixed costs in the first year will be $200,000. Doug is considering two ways of financing the firm: (a) 40% equity financing and 60% debt at 10%, or (b) 100% equity financing. He can sell common stock to his relatives for $10 per share. Either way, he will need to raise $1,000,000. -Calculate the Degree of Financial Leverage and the Degree of Combined Leverage under each of the possible financing plans.

Managers who are risk averse and uncertain about the future would most likely minimize combined leverage.

For firms in industries that offer some degree of stability,are in a positive stage of growth,and are operating in favourable economic conditions,the use of debt is not needed or recommended.

Management should tailor the use of leverage to meet its own risk-taking desires.

Cash break-even analysis eliminates the amortization expense and other non-cash charges from capital costs.

Operating leverage will change when a firm alters the mix of capital resources and labour that it uses.

The interwoven boundaries of banks and different trading companies in Japan make it easier to acquire credit in Japan than in Canada.

Heavy use of long-term debt may be beneficial in an inflationary economy because:

Sales (30,000 units ) \ 150,000 Variable costs Contribution margin 49,200 Fixed manufacturing costs Operating Income 25,200 Interest Earnings Before Taxes 7,200 Taxes (30\%) Net Income Shares Outstanding 600 -The Degree of Financial Leverage (DFL)is:

Cash break-even analysis:

A lower price for the firm's product will reduce the firm's break-even point.

Combined leverage is concerned with the relationship between:

Linear break-even analysis and operating leverage are only valid within a relevant range of production.