Exam 13: Leverage and Capital Structure

The lower risk nature of long-term debt in a firm's capital structure is due to the fact that ________.

Financial leverage measures the effect of fixed financial costs on the relationship between ________.

In general, a firm's theoretical optimal capital structure is that which balances the tax benefits of equity financing against the increase probability of bankruptcy that results from its use.

________ costs require the payment of a specified amount in each accounting period.

The pecking order explanation of capital structure states that a hierarchy of financing exists for firms, in which new external debt financing is employed first, followed by retained earnings and finally by external equity financing.

________ is the risk of being unable to cover financial obligations of a firm.

Holding all other factors constant, a firm that is subject to a greater level of business risk should employ less operating leverage than an otherwise equivalent firm that is subject to a lesser level of business risk.

Financial risk is the risk to a firm of being unable to cover operating costs.

A firm has fixed operating costs of $175,000, total sales revenue of $3,000,000 and total variable costs of $2,250,000. The firm's degree of operating leverage is ________.

The basic shortcoming of the EBIT-EPS approach to capital structure is ________.

The conflict resulting from a manager's desire to increase a firm's risk without increasing current borrowing costs and lenders' desire to limit lending is one effect of the ________ problem.

In general, non-U.S. companies have much higher debt ratios than their U.S. counterparts because financial markets are much more developed in the United States than elsewhere.

A firm's operating breakeven point is the level of sales necessary to cover all fixed operating costs.

The three basic types of leverage are ________.

An increase in cost (fixed cost or variable cost) tends to increase the operating breakeven point, whereas an increase in the sales price per unit will decrease the operating breakeven point.

Minimizing the weighted average cost of capital allows management to undertake a larger number of profitable projects, thereby further increasing the value of a firm.

In general, a firm's theoretical optimal capital structure is that which balances the tax benefits of debt financing against the increase probability of bankruptcy that result from its use.

The closer the base sales level used is to the operating breakeven point, the smaller the operating leverage.

A firm has an operating profit of $300,000, interest of $35,000, and a tax rate of 40 percent. The firm has an after-tax cost of debt of 5 percent and a cost of equity of 15 percent. The firm's target capital structure is set at a mix of 40 percent debt and 60 percent equity. Assuming this as the optimum capital structure, the value of the firm is ________.

Operating and financial constraints placed on a corporation by loan provision are ________.