Exam 13: Leverage and Capital Structure

In general, low times interest earned ratio and fixed-payment coverage ratio are associated with a high degree of financial leverage.

The basic shortcoming of EBIT-EPS analysis is that this model focuses on the maximization of earnings rather than on the maximization of owner wealth as reflected in a firm's stock price.

As fixed operating costs increase and all other factors are held constant, ________.

Comparison of the degree of operating leverage of two firms is valid only when the base level of sales used for each firm is the same.

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

Financial breakeven point represents the level of earnings after interest and taxes necessary for a firm to cover its fixed operating and financial changes-that is, the point at which dividends per share is equal to zero.

When considering fixed operating cost increases, a financial manager must weigh the increased financial risk associated with greater operating leverage against the expected increase in returns.

________ is 100 percent minus total variable operating costs as a percentage of total sales.

Debt capital is less risky than equity capital because a firm is legally obligated to pay interest to bondholders but they are not legally obligated to pay dividends to preferred or common stockholders.

Table 13.1 -At about what EBIT level should the financial manager be indifferent to either plan? (See Table 13.1)

The dollar breakeven sales level can be solved for by dividing fixed costs by the dollar contribution margin.

The risk of the debt capital is less than that of other long-term contributors of capital because ________.

After satisfying obligations to creditors, the government, and preferred stockholders, any remaining earnings will most likely be allocated to ________.

Revenue stability affects ________.

The cost of equity increases with increasing financial leverage in order to compensate the stockholders for the higher degree of financial risk.

Which of the following is true of leverage?

Since the sales price per unit generally decreases with volume and the cost per unit generally increases with volume, the true breakeven point may be different from those obtained using linear revenue and cost functions as assumed in the breakeven analysis.

________ costs are a function of time, not sales, and are typically contractual.

Both operating and financial leverage result in the magnification of return as well as risk.

Whenever the percentage change in EBIT resulting from a given percentage change in sales is greater than the percentage change in sales, operating leverage exists.