Question 1

Given the following financial data for Cosmos, compute the firm's degree of combined leverage.

Accepted Answer

A)  $0.42 
B)  8.37 
C)  -2.15 
D)  1.78 
A)  $0.42 
B)  8.37 
C)  -2.15 
D)  1.78

Question 2

Some companies use debt or preferred stock financing instead of common stock financing. The purpose is:

Accepted Answer

A)  to retain control 
B)  to facilitate record-keeping 
C)  to maintain privacy 
D)  to prevent audit problems 
A)  to retain control 
B)  to facilitate record-keeping 
C)  to maintain privacy 
D)  to prevent audit problems

Question 3

Rent, insurance, and the salaries of top management are examples of:

Accepted Answer

A)  fixed costs 
B)  capital costs 
C)  variable costs 
D)  fluctuating costs 
A)  fixed costs 
B)  capital costs 
C)  variable costs 
D)  fluctuating costs

Question 4

The degree of combined leverage is equal to the ____ multiplied by the ____.

Accepted Answer

A)  degree of operating leverage, variable cost ratio 
B)  degree of financial leverage, variable cost ratio 
C)  degree of operating leverage, degree of financial leverage 
D)  degree of operating leverage, fixed cost ratio 
A)  degree of operating leverage, variable cost ratio 
B)  degree of financial leverage, variable cost ratio 
C)  degree of operating leverage, degree of financial leverage 
D)  degree of operating leverage, fixed cost ratio

Question 5

When fixed operating costs are incurred by the firm, a change in ____ is magnified into a relatively larger change in earnings before interest and taxes.

Accepted Answer

A)  overhead expenses 
B)  interest charges 
C)  labor costs 
D)  sales revenue 
A)  overhead expenses 
B)  interest charges 
C)  labor costs 
D)  sales revenue

Question 6

TCA Cable has fixed operating cost of $2.6 million, and its variable cost ratio is 0.30. TCA has $4.0 in bonds outstanding with a coupon interest rate of 12%. TCA has 1.0 million common shares and 1,000,000 shares of $1.75 preferred stock outstanding. Total revenues for TCA Cable are $14.2 million. If TCA has a marginal tax rate of 40%, what is its degree of combined leverage?

Accepted Answer

A)  2.1 
B)  1.0 
C)  1.9 
D)  2.5 
A)  2.1 
B)  1.0 
C)  1.9 
D)  2.5

Question 7

A firm that employs a relatively large proportion of debt and preferred stock in its capital structure will have a relatively ____ degree of financial leverage.

Accepted Answer

A)  low 
B)  high 
C)  insignificant 
D)  constant 
A)  low 
B)  high 
C)  insignificant 
D)  constant

Question 8

Sulzar's capital structure consists only of common stock (20 million shares), but the firm is planning a major expansion which will require $100 million of new capital. Sulzar has a choice of obtaining the needed capital through the sale of 5 million shares of common stock at $20 per share or the sale of $100 million of first mortgage bonds that would have a coupon rate of 9%. If Sulzar has a marginal tax rate of 40%, calculate the EBIT-EPS indifference point.

Accepted Answer

A)  $45 million 
B)  $36 million 
C)  $5 million 
D)  $9 million 
A)  $45 million 
B)  $36 million 
C)  $5 million 
D)  $9 million

Question 9

Financial leverage causes a firm's ____ to change at a rate greater than the change in ____.

Accepted Answer

A)  EBIT; EPS 
B)  EPS; EBIT 
C)  EBIT; sales 
D)  sales; EBIT 
A)  EBIT; EPS 
B)  EPS; EBIT 
C)  EBIT; sales 
D)  sales; EBIT

Question 10

Higgins currently has 2 million shares of common stock outstanding that are selling for $32 per share. Higgins also has a $20 million mortgage bond outstanding that has an 11 percent coupon rate. Higgins is considering two alternatives to financing a major expansion. Plan A is to sell $10 million of additional long-term debt with a 12.5 percent coupon. Plan B is to sell 200,000 shares of common stock at $30 per share and $4 million in long-term debt with a 11.25 percent coupon. What is the EBIT indifference level between these two alternatives? Assume the marginal tax rate is 40 percent.

Accepted Answer

A)  $1,374,000 
B)  $11,450,000 
C)  $4,554,000 
D)  $2,650,000 
A)  $1,374,000 
B)  $11,450,000 
C)  $4,554,000 
D)  $2,650,000

Question 11

Chemex has a cash and marketable securities balance of $200 million. Management expects free cash flows of $320 million during the coming year. If management is considering a restructuring of its capital structure that would add an additional $350 million of annual fixed financial charges, what is the expected cash balance at the end of the year?

Accepted Answer

A)  -$30 million 
B)  $170 million 
C)  $230 million 
D)  $470 million 
A)  -$30 million 
B)  $170 million 
C)  $230 million 
D)  $470 million

Question 12

Two companies, Jefferson and Jackson, are virtually identical in all aspects of their operations except that the two companies differ in their capital structures, as shown below:  
Both companies have $500 million in total assets and both have a 40% marginal tax rate.What is the EPS for Jackson at an EBIT level of $50 million?

Accepted Answer

A)  $1.50 
B)  $1.20 
C)  $2.00 
D)  $2.50 
A)  $1.50 
B)  $1.20 
C)  $2.00 
D)  $2.50

Question 13

There are three categories of costs: fixed costs, variable costs and semi-variable costs. Which of the following is a semi-variable cost?

Accepted Answer

A)  depreciation 
B)  labor costs 
C)  raw materials 
D)  management salaries 
A)  depreciation 
B)  labor costs 
C)  raw materials 
D)  management salaries

Question 14

A firm which has a 2.5 DOL (degree of operating leverage) would find that an 8% increase in EBIT would result from a ____ increase in sales.

Accepted Answer

A)  3.2% 
B)  5.4% 
C)  20.0% 
D)  2.0% 
A)  3.2% 
B)  5.4% 
C)  20.0% 
D)  2.0%

Question 15

Some firms prefer to use debt or preferred stock for financing to retain control. Explain the rationale behind this method.

Accepted Answer

Some firms choose debt or preferred stoc

Question 16

ASG expects next year's operating income (EBIT) to equal $22 million, with a standard deviation of $16 million. The coefficient of variation of operating income is equal to 0.73. Interest expenses will be $9 million next year and debt retirement will require a principal payment of $2.5 million. ASG's marginal tax rate is 40%. If EBIT is normally distributed, what is the probability that ASG will have a negative EPS next year?

Accepted Answer

A)  20.9% 
B)  25.5% 
C)  23.3% 
D)  25.8% 
A)  20.9% 
B)  25.5% 
C)  23.3% 
D)  25.8%

Question 17

In evaluating degree of operating leverage , it is best that the firm's DOL is:

Accepted Answer

A)  higher than 1 
B)  higher than 2 
C)  lower than 1 
D)  equal to 1 
A)  higher than 1 
B)  higher than 2 
C)  lower than 1 
D)  equal to 1

Question 18

What are the effects of leverage on shareholder wealth and the cost of capital?

Accepted Answer

Firms are limited in the amount of combi

Question 19

A DFL (degree of financial leverage) of 3.0 indicates that a 27% increase in EPS is the result of a ____ increase in EBIT.

Accepted Answer

A)  81% 
B)  3% 
C)  9% 
D)  6% 
A)  81% 
B)  3% 
C)  9% 
D)  6%

Question 20

Onex expects to have an EBIT of $240,000 with a standard deviation of $90,000. The distribution of operating income is approximately normal. What is the probability that Onex will have an EBIT that is below $0?

Accepted Answer

A)  0.47% 
B)  2.67% 
C)  0.38% 
D)  2.25% 
A)  0.47% 
B)  2.67% 
C)  0.38% 
D)  2.25%

Exam 14: Capital Structure Management in Practice

Given the following financial data for Cosmos, compute the firm's degree of combined leverage.

Some companies use debt or preferred stock financing instead of common stock financing. The purpose is:

Rent, insurance, and the salaries of top management are examples of:

The degree of combined leverage is equal to the ____ multiplied by the ____.

When fixed operating costs are incurred by the firm, a change in ____ is magnified into a relatively larger change in earnings before interest and taxes.

A firm that employs a relatively large proportion of debt and preferred stock in its capital structure will have a relatively ____ degree of financial leverage.

Financial leverage causes a firm's ____ to change at a rate greater than the change in ____.

There are three categories of costs: fixed costs, variable costs and semi-variable costs. Which of the following is a semi-variable cost?

A firm which has a 2.5 DOL (degree of operating leverage) would find that an 8% increase in EBIT would result from a ____ increase in sales.

Some firms prefer to use debt or preferred stock for financing to retain control. Explain the rationale behind this method.

In evaluating degree of operating leverage , it is best that the firm's DOL is:

What are the effects of leverage on shareholder wealth and the cost of capital?

A DFL (degree of financial leverage) of 3.0 indicates that a 27% increase in EPS is the result of a ____ increase in EBIT.

Onex expects to have an EBIT of $240,000 with a standard deviation of $90,000. The distribution of operating income is approximately normal. What is the probability that Onex will have an EBIT that is below $0?

The Role and Objective of Financial Management

The Domestic and International Financial Marketplace

Evaluation of Financial Performance

Financial Planning and Forecasting

The Time Value of Money

Fixed Income Securities: Characteristics and Valuation

Common Stock: Characteristics, Valuation, and Issuance

Analysis of Risk and Return

Capital Budgeting and Cash Flow Analysis

Capital Budgeting: Decision Criteria and Real Option Considerations

Capital Budgeting and Risk

The Cost of Capital

Capital Structure Concepts

Dividend Policy

Working Capital Policy and Short-term Financing

The Management of Cash and Marketable Securities

Management of Accounts Receivable and Inventories

Lease and Intermediate-term Financing

Financing With Derivatives

Risk Management

International Financial Management

Corporate Restructuring

Continuous Compounding and Discounting

Mutually Exclusive Investments Having Unequal Lives

Breakeven Analysis

Bond Refunding Analysis

Taxes

Filters

The degree of combined leverage is equal to the multiplied by the .

Financial leverage causes a firm's to change at a rate greater than the change in .