Question 1

Which of the following affects business risk?

Accepted Answer

A)  operating leverage 
B)  interest rate stability 
C)  preferred stock 
D)  financial lease 
A)  operating leverage 
B)  interest rate stability 
C)  preferred stock 
D)  financial lease

Question 2

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

Accepted Answer

A)  the equity holders are the true owners of the firm 
B)  equity capital has a fixed return 
C)  interest payments are tax-deductible 
D)  equity holders have a higher position in the priority of claims 
A)  the equity holders are the true owners of the firm 
B)  equity capital has a fixed return 
C)  interest payments are tax-deductible 
D)  equity holders have a higher position in the priority of claims

Question 3

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

Accepted Answer

A) True 
 B)False

Question 4

The overriding objective of the capital structure decision should be to choose the level of debt that results in the largest possible share price.

Accepted Answer

A) True 
 B)False

Question 5

A firm has fixed operating costs of $253,750, a sales price per unit of $100, and a variable cost per unit of $65. The firm's operating breakeven point in dollars is ________.

Accepted Answer

A)  $725,000 
B)  $700,000 
C)  $906,250 
D)  $390,385 
A)  $725,000 
B)  $700,000 
C)  $906,250 
D)  $390,385

Question 6

Business risk is the risk to the firm of being unable to cover required financial obligations.

Accepted Answer

A) True 
 B)False

Question 7

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

Accepted Answer

A) True 
 B)False

Question 8

A corporation has $10,000,000 of 10 percent preferred stock outstanding and a 40 percent tax rate. The amount of earnings before interest and taxes (EBIT) required to pay the preferred dividends is ________.

Accepted Answer

A)  $1,000,000 
B)  $400,000 
C)  $600,000 
D)  $1,666,667 
A)  $1,000,000 
B)  $400,000 
C)  $600,000 
D)  $1,666,667

Question 9

Management has just discovered an excellent investment for which it needs additional funding. Relative to the discussion on asymmetric information, the firm should ________.

Accepted Answer

A)  finance with new common stock if management believes the firm is undervalued 
B)  finance with debt if management believes the firm is undervalued 
C)  finance with debt if management believes the firm is overvalued 
D)  finance with preferred stock if the firm is at value 
A)  finance with new common stock if management believes the firm is undervalued 
B)  finance with debt if management believes the firm is undervalued 
C)  finance with debt if management believes the firm is overvalued 
D)  finance with preferred stock if the firm is at value

Question 10

Whenever the percentage change in earnings per share (EPS) resulting from a given percentage change in sales is greater than the percentage change in sales, financial leverage exists.

Accepted Answer

A) True 
 B)False

Question 11

At the operating breakeven point, ________ equals zero.

Accepted Answer

A)  sales revenue 
B)  fixed operating costs 
C)  variable operating costs 
D)  earnings before interest and taxes 
A)  sales revenue 
B)  fixed operating costs 
C)  variable operating costs 
D)  earnings before interest and taxes

Question 12

In the traditional approach to capital structure, as the amount of debt increases in a firm's capital structure, ________.

Accepted Answer

A)  the cost of equity rises faster than the cost of debt 
B)  the cost of debt rises faster than the cost of equity 
C)  debt becomes less risky 
D)  equity cost is unaffected 
A)  the cost of equity rises faster than the cost of debt 
B)  the cost of debt rises faster than the cost of equity 
C)  debt becomes less risky 
D)  equity cost is unaffected

Question 13

Operating leverage is concerned with the relationship between a firm's sales revenue and its financial expenses.

Accepted Answer

A) True 
 B)False

Question 14

The optimal capital structure is the one that balances ________.

Accepted Answer

A)  return and risk factors in order to maximize profits 
B)  return and risk factors in order to maximize earnings per share 
C)  return and risk factors in order to maximize market value 
D)  return and risk factors in order to maximize dividends 
A)  return and risk factors in order to maximize profits 
B)  return and risk factors in order to maximize earnings per share 
C)  return and risk factors in order to maximize market value 
D)  return and risk factors in order to maximize dividends

Question 15

At a base sales level of $400,000, a firm has a degree of operating leverage of 2 and a degree of financial leverage of 1.5. The firm's degree of total leverage is ________.

Accepted Answer

A)  3.5 
B)  3.0 
C)  0.5 
D)  1.3 
A)  3.5 
B)  3.0 
C)  0.5 
D)  1.3

Question 16

A firm has interest expense of $145,000, preferred dividends of $25,000, and a tax rate of 40 percent. The firm's financial breakeven point is ________.

Accepted Answer

A)  $ 25,000 
B)  $170,000 
C)  $186,667 
D)  $145,000 
A)  $ 25,000 
B)  $170,000 
C)  $186,667 
D)  $145,000

Question 17

Generally, increases in leverage result in ________ return and ________ risk.

Accepted Answer

A)  decreased; increased 
B)  decreased; decreased 
C)  increased; increased 
D)  increased; decreased 
A)  decreased; increased 
B)  decreased; decreased 
C)  increased; increased 
D)  increased; decreased

Question 18

A shift toward more fixed costs increases business risk, which in turn causes earnings before interest and taxes to increase by less for a given increase in sales.

Accepted Answer

A) True 
 B)False

Question 19

As debt is substituted for equity in the capital structure and the debt ratio increases, the behavior of the overall cost of capital is partially explained by ________.

Accepted Answer

A)  the tax-deductibility of interest payments 
B)  the increase in the number of common shares outstanding 
C)  the reduction in risk as perceived by the common shareholders 
D)  the decrease in the cost of equity 
A)  the tax-deductibility of interest payments 
B)  the increase in the number of common shares outstanding 
C)  the reduction in risk as perceived by the common shareholders 
D)  the decrease in the cost of equity

Question 20

Yongman Electronics has decided to invest $10,000,000 in a new headquarters and needs to determine the best way to finance the construction. The firm currently has $50,000,000 of 10 percent bonds and 4,000,000 common shares outstanding. The firm can obtain the $10,000,000 of financing through a 10 percent bond issue or the sale of 1,000,000 shares of common stock. The firm has a 40 percent tax rate.
(a) What is the degree of financial leverage for each plan at $25,000,000 of EBIT?
(b) What is the financial breakeven point for each plan?

Accepted Answer

(a) Bond issue interest = $10,000,000 ×

Which of the following affects business risk?

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

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

The overriding objective of the capital structure decision should be to choose the level of debt that results in the largest possible share price.

A firm has fixed operating costs of $253,750, a sales price per unit of $100, and a variable cost per unit of $65. The firm's operating breakeven point in dollars is ________.

Business risk is the risk to the firm of being unable to cover required financial obligations.

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

A corporation has $10,000,000 of 10 percent preferred stock outstanding and a 40 percent tax rate. The amount of earnings before interest and taxes (EBIT) required to pay the preferred dividends is ________.

Management has just discovered an excellent investment for which it needs additional funding. Relative to the discussion on asymmetric information, the firm should ________.

Whenever the percentage change in earnings per share (EPS) resulting from a given percentage change in sales is greater than the percentage change in sales, financial leverage exists.

At the operating breakeven point, ________ equals zero.

In the traditional approach to capital structure, as the amount of debt increases in a firm's capital structure, ________.

Operating leverage is concerned with the relationship between a firm's sales revenue and its financial expenses.

The optimal capital structure is the one that balances ________.

At a base sales level of $400,000, a firm has a degree of operating leverage of 2 and a degree of financial leverage of 1.5. The firm's degree of total leverage is ________.

A firm has interest expense of $145,000, preferred dividends of $25,000, and a tax rate of 40 percent. The firm's financial breakeven point is ________.

Generally, increases in leverage result in return and risk.

A shift toward more fixed costs increases business risk, which in turn causes earnings before interest and taxes to increase by less for a given increase in sales.

As debt is substituted for equity in the capital structure and the debt ratio increases, the behavior of the overall cost of capital is partially explained by ________.

The Role of Managerial Finance

The Financial Market Environment

Financial Statements and Ratio Analysis

Cash Flow and Financial Planning

Time Value of Money

Interest Rates and Bond Valuation

Stock Valuation

Risk and Return

The Cost of Capital

Capital Budgeting Techniques

Capital Budgeting Cash Flows

Risk and Refinements in Capital Budgeting

Payout Policy

Working Capital and Current Assets Management

Current Liabilities Management

Hybrid and Derivative Securities

Mergers, Lbos, Divestitures, and Business Failure

International Managerial Finance

Filters

Exam 13: Leverage and Capital Structure

Which of the following affects business risk?

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

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

The overriding objective of the capital structure decision should be to choose the level of debt that results in the largest possible share price.

A firm has fixed operating costs of $253,750, a sales price per unit of $100, and a variable cost per unit of $65. The firm's operating breakeven point in dollars is ________.

Business risk is the risk to the firm of being unable to cover required financial obligations.

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

A corporation has $10,000,000 of 10 percent preferred stock outstanding and a 40 percent tax rate. The amount of earnings before interest and taxes (EBIT) required to pay the preferred dividends is ________.

Management has just discovered an excellent investment for which it needs additional funding. Relative to the discussion on asymmetric information, the firm should ________.

Whenever the percentage change in earnings per share (EPS) resulting from a given percentage change in sales is greater than the percentage change in sales, financial leverage exists.

At the operating breakeven point, ________ equals zero.

In the traditional approach to capital structure, as the amount of debt increases in a firm's capital structure, ________.

Operating leverage is concerned with the relationship between a firm's sales revenue and its financial expenses.

The optimal capital structure is the one that balances ________.

At a base sales level of $400,000, a firm has a degree of operating leverage of 2 and a degree of financial leverage of 1.5. The firm's degree of total leverage is ________.

A firm has interest expense of $145,000, preferred dividends of $25,000, and a tax rate of 40 percent. The firm's financial breakeven point is ________.

Generally, increases in leverage result in ________ return and ________ risk.

A shift toward more fixed costs increases business risk, which in turn causes earnings before interest and taxes to increase by less for a given increase in sales.

As debt is substituted for equity in the capital structure and the debt ratio increases, the behavior of the overall cost of capital is partially explained by ________.

The Role of Managerial Finance

The Financial Market Environment

Financial Statements and Ratio Analysis

Cash Flow and Financial Planning

Time Value of Money

Interest Rates and Bond Valuation

Stock Valuation

Risk and Return

The Cost of Capital

Capital Budgeting Techniques

Capital Budgeting Cash Flows

Risk and Refinements in Capital Budgeting

Payout Policy

Working Capital and Current Assets Management

Current Liabilities Management

Hybrid and Derivative Securities

Mergers, Lbos, Divestitures, and Business Failure

International Managerial Finance

Filters

Generally, increases in leverage result in return and risk.