Question 1

The degree of operating leverage has which of the following characteristics?

Accepted Answer

A) The closer the firm is operating to the breakeven quantity, the smaller the DOL. 
B) A change in quantity demanded will produce the same percentage change in EBIT as an identical change in price per unit of output, other things held constant. 
C) The DOL is not a fixed number for a given firm, but will depend upon the time zero values of the economic variable Q (Quantity), P (Price), and V (Volume). 
D) The DOL relates the change in net income to the change in operating income. 
E) If the firm has no debt, the DOL will equal 1. 
A) The closer the firm is operating to the breakeven quantity, the smaller the DOL. 
B) A change in quantity demanded will produce the same percentage change in EBIT as an identical change in price per unit of output, other things held constant. 
C) The DOL is not a fixed number for a given firm, but will depend upon the time zero values of the economic variable Q (Quantity), P (Price), and V (Volume). 
D) The DOL relates the change in net income to the change in operating income. 
E) If the firm has no debt, the DOL will equal 1. C

Question 2

Bell Brothers has $3,000,000 in sales.Fixed costs are estimated to be $100,000 and variable costs are equal to 50% of sales.The company has $1,000,000 in debt outstanding at a before-tax cost of 10%.If Bell Brothers' sales were to increase by 20%,how much of a percentage increase would you expect in the company's net income?

Accepted Answer

A) 18.80% 
B) 19.79% 
C) 20.83% 
D) 21.92% 
E) 23.08% 
A) 18.80% 
B) 19.79% 
C) 20.83% 
D) 21.92% 
E) 23.08% E

Question 3

The Quick Company expects its sales to increase by 50% in the coming year.The firm's current EPS is $3.25.Its degree of operating leverage is 1.6,while its degree of financial leverage is 2.1.What is the firm's projected EPS for the coming year using the DTL approach?

Accepted Answer

A) $7.47 
B) $7.86 
C) $8.27 
D) $8.71 
E) $9.15 
A) $7.47 
B) $7.86 
C) $8.27 
D) $8.71 
E) $9.15 D

Question 4

Stromburg Corporation makes surveillance equipment for intelligence organizations.Its sales are $75,000,000.Fixed costs,including research and development,are $40,000,000,while variable costs amount to 30% of sales.Stromburg plans an expansion which will generate additional fixed costs of $15,000,000,decrease variable costs to 25% of sales,and also permit sales to increase to $100,000,000.What is Stromburg's degree of operating leverage at the new projected sales level?

Accepted Answer

A) 3.7500 
B) 3.9375 
C) 4.1344 
D) 4.3411 
E) 4.5581 
A) 3.7500 
B) 3.9375 
C) 4.1344 
D) 4.3411 
E) 4.5581

Question 5

Monroe Corporation currently sells 150,000 units a year at a price of $4.00 a unit.Its variable costs are approximately 30% of sales,and its fixed costs amount to 50% of revenues at its current output level.Although fixed costs are based on revenues at the current output level,the cost level is fixed.What is Marcus's degree of operating leverage in sales dollars?

Accepted Answer

A) 3.1588 
B) 3.3250 
C) 3.5000 
D) 3.6750 
E) 3.8588 
A) 3.1588 
B) 3.3250 
C) 3.5000 
D) 3.6750 
E) 3.8588

Question 6

Assume that a firm currently has EBIT of $2,000,000,a degree of total leverage of 7.5,and a degree of financial leverage of 1.875.If sales decline by 20% next year,then what will be the firm's expected EBIT in one year?

Accepted Answer

A) $361,000 
B) $380,000 
C) $400,000 
D) $420,000 
E) $441,000 
A) $361,000 
B) $380,000 
C) $400,000 
D) $420,000 
E) $441,000

Question 7

The "degree of leverage" concept is designed to show how changes in sales will affect EBIT and EPS.If a 10% increase in sales causes EPS to increase from $1.00 to $1.50,and if the firm uses no debt,then what is its degree of operating leverage?

Accepted Answer

A) 4.2869 
B) 4.5125 
C) 4.7500 
D) 5.0000 
E) 5.2500 
A) 4.2869 
B) 4.5125 
C) 4.7500 
D) 5.0000 
E) 5.2500

Question 8

A company currently sells 75,000 units annually.At this sales level,its EBIT is $4 million,and its degree of total leverage is 2.0.The firm's debt consists of $15 million in bonds with a 9.5% coupon.The company is considering a new production method which will entail an increase in fixed costs but a decrease in variable costs,and will result in a degree of operating leverage of 1.600.The president,who is concerned about the stand-alone risk of the firm,wants to keep the degree of total leverage at 2.0.If EBIT remains at $4 million,what dollar amount of bonds must be retired to accomplish this?

Accepted Answer

A) $5,640,625 
B) $5,937,500 
C) $6,250,000 
D) $6,578,947 
E) $6,907,895 
A) $5,640,625 
B) $5,937,500 
C) $6,250,000 
D) $6,578,947 
E) $6,907,895

Question 9

Which of the following statements is CORRECT?

Accepted Answer

A) An increase in fixed costs, (holding sales and variable costs constant) will reduce the company's degree of operating leverage. 
B) An increase in interest expense will reduce the company's degree of financial leverage. 
C) If the company has no debt outstanding, then its degree of total leverage equals its degree of operating leverage. 
D) If a firm's degree of operating leverage increases, its degree of financial leverage must also have increased. 
E) If the company has no debt outstanding, then its degree of total leverage equals its degree of financial leverage. 
A) An increase in fixed costs, (holding sales and variable costs constant) will reduce the company's degree of operating leverage. 
B) An increase in interest expense will reduce the company's degree of financial leverage. 
C) If the company has no debt outstanding, then its degree of total leverage equals its degree of operating leverage. 
D) If a firm's degree of operating leverage increases, its degree of financial leverage must also have increased. 
E) If the company has no debt outstanding, then its degree of total leverage equals its degree of financial leverage.

Question 10

If a firm uses debt financing (Debt ratio = 0.40)and sales change from the current level,which of the following statements is CORRECT?

Accepted Answer

A) The percentage change in operating income (EBIT) resulting from the change in sales will exceed the percentage change in net income. 
B) The percentage change in EBIT will equal the percentage change in net income. 
C) The percentage change in net income relative to the percentage change in sales (and in EBIT) will not depend on the interest rate paid on the debt. 
D) The percentage change in operating income will be less than the percentage change in net income. 
E) Since debt is used, the degree of operating leverage must be greater than 1. 
A) The percentage change in operating income (EBIT) resulting from the change in sales will exceed the percentage change in net income. 
B) The percentage change in EBIT will equal the percentage change in net income. 
C) The percentage change in net income relative to the percentage change in sales (and in EBIT) will not depend on the interest rate paid on the debt. 
D) The percentage change in operating income will be less than the percentage change in net income. 
E) Since debt is used, the degree of operating leverage must be greater than 1.

Question 11

The use of financial leverage by the firm has a potential impact on which of the following?
(1)The risk associated with the firm.
(2)The return experienced by the shareholder.
(3)The variability of net income.
(4)The degree of operating leverage.
(5)The degree of financial leverage.

Accepted Answer

A) 1, 3, 5 
B) 1, 2, 5 
C) 2, 3, 5 
D) 2, 3, 4, 5 
E) 1, 2, 3, 5 
A) 1, 3, 5 
B) 1, 2, 5 
C) 2, 3, 5 
D) 2, 3, 4, 5 
E) 1, 2, 3, 5

Question 12

Assume that a firm has a degree of financial leverage of 1.25.If sales increase by 20%,the firm will experience a 60% increase in EPS,and it will have an EBIT of $100,000.What will be the EBIT for this firm if sales do not increase?

Accepted Answer

A) $57,931 
B) $60,980 
C) $64,189 
D) $67,568 
E) $70,946 
A) $57,931 
B) $60,980 
C) $64,189 
D) $67,568 
E) $70,946

Question 13

Company D has a 50% debt ratio,whereas Company E has no debt financing.The two companies have the same level of sales and the same degree of operating leverage.Which of the following statements is most CORRECT?

Accepted Answer

A) If sales increase 10% for both companies, then Company D will have a larger percentage increase in its net income. 
B) If sales increase 10% for both companies, then Company D will have a larger percentage increase in its operating income (EBIT). 
C) If EBIT increases 10% for both companies, then Company D's net income will rise by more than 10%, while Company E's net income will rise by less than 10%. 
D) Company E has a higher degree of financial leverage. 
E) The two companies have the same degree of total leverage. 
A) If sales increase 10% for both companies, then Company D will have a larger percentage increase in its net income. 
B) If sales increase 10% for both companies, then Company D will have a larger percentage increase in its operating income (EBIT). 
C) If EBIT increases 10% for both companies, then Company D's net income will rise by more than 10%, while Company E's net income will rise by less than 10%. 
D) Company E has a higher degree of financial leverage. 
E) The two companies have the same degree of total leverage.

Question 14

Which of the following is a key benefit of using the degree of leverage concept in financial analysis?

Accepted Answer

A) It allows decision makers a relatively clear assessment of the consequences of alternative actions. 
B) It establishes the optimal capital structure for the firm. 
C) It shows how a given change in leverage will affect sales. 
D) It identifies, with certainty, the future net income based upon sales projections about the future. 
E) None of the above statements is correct. 
A) It allows decision makers a relatively clear assessment of the consequences of alternative actions. 
B) It establishes the optimal capital structure for the firm. 
C) It shows how a given change in leverage will affect sales. 
D) It identifies, with certainty, the future net income based upon sales projections about the future. 
E) None of the above statements is correct.

Question 15

Lincoln Lodging Inc.estimates that if its sales increase 10% then its net income will increase 18%.The company's EBIT equals $2.4 million,and its interest expense is $400,000.The company's operating costs include fixed and variable costs.What is the level of the company's fixed operating costs?

Accepted Answer

A) $1,083,000 
B) $1,140,000 
C) $1,200,000 
D) $1,260,000 
E) $1,323,000 
A) $1,083,000 
B) $1,140,000 
C) $1,200,000 
D) $1,260,000 
E) $1,323,000

Question 16

Coats Corp.generates $10,000,000 in sales.Its variable costs equal 85% of sales and its fixed costs are $500,000.Therefore,the company's operating income (EBIT)equals $1,000,000.The company estimates that if its sales were to increase 10%,its net income and EPS would increase 17.5%.What is the company's interest expense?

Accepted Answer

A) $122,482 
B) $128,929 
C) $135,714 
D) $142,857 
E) $150,000 
A) $122,482 
B) $128,929 
C) $135,714 
D) $142,857 
E) $150,000

Question 17

Kulwicki Corporation wants to determine the effect of an expansion of its sales on its operating income (EBIT).The firm's current degree of operating leverage is 2.50.It projects new unit sales to be 170,000,an increase of 45,000 over last year's level of 125,000 units.Last year's EBIT was $60,000.Based on a degree of operating leverage of 2.5,what is this year's expected EBIT with the increase in sales?

Accepted Answer

A) $ 92,854 
B) $ 97,741 
C) $102,885 
D) $108,300 
E) $114,000 
A) $ 92,854 
B) $ 97,741 
C) $102,885 
D) $108,300 
E) $114,000

Question 18

Maxvill Motors has annual sales of $15,000.Its variable costs equal 60% of its sales and its fixed costs equal $1,000.If the company's sales increase 10%,what will be the percentage increase in the company's earnings before interest and taxes (EBIT)?

Accepted Answer

A) 12.00% 
B) 12.60% 
C) 13.23% 
D) 13.89% 
E) 14.59% 
A) 12.00% 
B) 12.60% 
C) 13.23% 
D) 13.89% 
E) 14.59%

Question 19

Which of the following statements is CORRECT?

Accepted Answer

A) The degree of operating leverage (DOL) depends on a company's fixed costs, variable costs, and sales. The DOL formula assumes (1) that fixed costs are constant and (2) that variable costs are a constant proportion of sales. 
B) The degree of total leverage (DTL) is equal to the DOL plus the degree of financial leverage (DFL). 
C) Arithmetically, financial leverage and operating leverage offset one another so as to keep the degree of total leverage constant. Therefore, the formula shows that the greater the degree of financial leverage, the smaller the degree of operating leverage. 
D) For a given change in sales, the corresponding percentage change in net income could be more or less than the percentage change in operating income. 
E) The degree of total leverage (DTL) is equal to the DFL divided by the degree of operating leverage (DOL). 
A) The degree of operating leverage (DOL) depends on a company's fixed costs, variable costs, and sales. The DOL formula assumes (1) that fixed costs are constant and (2) that variable costs are a constant proportion of sales. 
B) The degree of total leverage (DTL) is equal to the DOL plus the degree of financial leverage (DFL). 
C) Arithmetically, financial leverage and operating leverage offset one another so as to keep the degree of total leverage constant. Therefore, the formula shows that the greater the degree of financial leverage, the smaller the degree of operating leverage. 
D) For a given change in sales, the corresponding percentage change in net income could be more or less than the percentage change in operating income. 
E) The degree of total leverage (DTL) is equal to the DFL divided by the degree of operating leverage (DOL).

Question 20

A company has an EBIT of $4 million,and its degree of total leverage is 2.4.The firm's debt consists of $20 million in bonds with a YTM of 10%.The company is considering a new production process that will require an increase in fixed costs but a decrease in variable costs.If adopted,the new process will result in a degree of operating leverage of 1.4.The president wants to keep the degree of total leverage at 2.4.If EBIT remains at $4 million,what dollar amount of bonds must be outstanding to accomplish this (assuming the yield to maturity remains at 10%)?

Accepted Answer

A) $16,666,667 
B) $17,500,000 
C) $18,375,000 
D) $19,293,750 
E) $20,258,438 
A) $16,666,667 
B) $17,500,000 
C) $18,375,000 
D) $19,293,750 
E) $20,258,438

Exam 28: Degree of Leverage

The degree of operating leverage has which of the following characteristics?

The Quick Company expects its sales to increase by 50% in the coming year.The firm's current EPS is $3.25.Its degree of operating leverage is 1.6,while its degree of financial leverage is 2.1.What is the firm's projected EPS for the coming year using the DTL approach?

Assume that a firm currently has EBIT of $2,000,000,a degree of total leverage of 7.5,and a degree of financial leverage of 1.875.If sales decline by 20% next year,then what will be the firm's expected EBIT in one year?

The "degree of leverage" concept is designed to show how changes in sales will affect EBIT and EPS.If a 10% increase in sales causes EPS to increase from $1.00 to $1.50,and if the firm uses no debt,then what is its degree of operating leverage?

Which of the following statements is CORRECT?

If a firm uses debt financing (Debt ratio = 0.40)and sales change from the current level,which of the following statements is CORRECT?

The use of financial leverage by the firm has a potential impact on which of the following? (1)The risk associated with the firm. (2)The return experienced by the shareholder. (3)The variability of net income. (4)The degree of operating leverage. (5)The degree of financial leverage.

Assume that a firm has a degree of financial leverage of 1.25.If sales increase by 20%,the firm will experience a 60% increase in EPS,and it will have an EBIT of $100,000.What will be the EBIT for this firm if sales do not increase?

Company D has a 50% debt ratio,whereas Company E has no debt financing.The two companies have the same level of sales and the same degree of operating leverage.Which of the following statements is most CORRECT?

Which of the following is a key benefit of using the degree of leverage concept in financial analysis?

Lincoln Lodging Inc.estimates that if its sales increase 10% then its net income will increase 18%.The company's EBIT equals $2.4 million,and its interest expense is $400,000.The company's operating costs include fixed and variable costs.What is the level of the company's fixed operating costs?

Maxvill Motors has annual sales of $15,000.Its variable costs equal 60% of its sales and its fixed costs equal $1,000.If the company's sales increase 10%,what will be the percentage increase in the company's earnings before interest and taxes (EBIT)?

Which of the following statements is CORRECT?

An Overview of Financial Management

Financial Markets and Institutions

Financial Statements, cash Flow, and Taxes

Analysis of Financial Statements

Time Value of Money

Interest Rates

Bonds and Their Valuation

Risk and Rates of Return

Stocks and Their Valuation

The Cost of Capital

The Basics of Capital Budgeting

Cash Flow Estimation and Risk Analysis

Real Options and Other Topics in Capital Budgeting

Capital Structure and Leverage

Distributions to Shareholders: Dividends and Share Repurchases

Working Capital Management

Financial Planning and Forecasting

Derivatives and Risk Management

Multinational Financial Management

Hybrid Financing: Preferred Stock, leasing, warrants, and Convertibles

Mergers and Acquisitions

Continuous Compounding and Discounting

Zero Coupon Bonds

Bankruptcy and Reorganization

Calculating Beta Coefficients

Using the Capm to Estimate the Risk-Adjusted Cost of Capital

Techniques for Measuring Beta Risk

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