Exam 13: Leverage and Capital Structure

A firm has a current capital structure consisting of $400,000 of 12 percent annual interest debt and 50,000 shares of common stock. The firm's tax rate is 40 percent on ordinary income. If the EBIT is expected to be $200,000, two EBIT-EPS coordinates for the firm's existing capital structure are ________.

Table 13.1 -Assuming a 40 percent tax rate, what is the financial breakeven point for each plan? (See Table 13.1)

The EBIT-EPS approach to capital structure proposes that an optimal capital structure be selected which ________.

In the EBIT-EPS approach to capital structure, a constant level of EBIT is assumed ________.

The relationship between operating and financial leverage is additive rather than multiplicative.

A firm has fixed operating costs of $650,000, a sales price per unit of $20, and a variable cost per unit of $13. At a base sales level of 500,000 units, the firm's degree of operating leverage is ________.

In theory, a firm should maintain financial leverage consistent with a capital structure that ________.

Table 13.1 -What is the EPS under Financing Plan 1, if the firm projects EBIT of $200,000 and has a tax rate of 40 percent? (See Table 13.1)

A firm's operating breakeven point is the point at which ________.

________ leverage is concerned with the relationship between earnings before interest and taxes and earnings per share.

All items on the right-hand side of a firm's balance sheet, excluding current liabilities are sources of capital.

A firm has fixed operating costs of $10,000, the sale price per unit of its product is $25, and its variable cost per unit is $15. The firm's operating breakeven point in units is ________ and its breakeven point in dollars is ________.

A corporation has $5,000,000 of 8 percent preferred stock outstanding and a 40 percent tax rate. The after-tax cost of the preferred stock is ________.

A firm has fixed operating costs of $25,000, a per unit sales price of $5, and a variable cost per unit of $3. What is its operating breakeven point if it targets net operating income of $10,000?

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

Beijing Berings is considering purchasing a small firm in the same line of business. The purchase would be financed by the sale of common stock or a bond issue. The financial manager needs to evaluate how the two alternative financing plans will affect the earnings potential of the firm. Total financing required is $4.5 million. The firm currently has $20,000,000 of 12 percent bonds and 600,000 common shares outstanding. The firm can arrange financing of the $4.5 million through a 14 percent bond issue or the sale of 100,000 shares of common stock. The firm has a 40 percent tax rate. (a) What is the degree of financial leverage for each plan at $7,000,000 of EBIT? (b) What is the financial breakeven point for each plan?

An increase in fixed operating and financial cost results in an increase in risk, since the firm will have to achieve a higher level of sales just to break even.

The base level of sales must be held constant to compare the total leverage associated with different levels of fixed costs.

The more fixed cost financing a firm has in its capital structure, the greater is its financial leverage and risk.

A firm has fixed operating costs of $150,000, total sales of $1,500,000, and total variable costs of $1,275,000. The firm's operating breakeven point in dollars is ________.