Exam 13: Leverage and Capital Structure

Which of the following is a difference between debt and equity capital?

________ is the potential use of fixed costs to magnify the effect of changes in sales on the firm's earnings per share.

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

The degree of operating leverage will increase if a firm decides to compensate its sales representatives with a fixed salary and bonus rather than with a pure percent-of-sales commission.

Table 13.1 -Which plan has a higher degree of financial leverage and financial risk? (See Table 13.1)

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

Effective capital structure decisions can lower the cost of capital, resulting in higher NPVs and more acceptable projects, thereby increasing the value of a firm.

The degree of financial leverage is the ratio of ________ to percentage change in EBIT.

A corporation borrows $1,000,000 at 10 percent annual rate of interest. The firm has a 40 percent tax rate. The yearly, after-tax cost of this debt is ________.

Table 13.1 -What is the degree of financial leverage at a base level EBIT of $120,000 for both financing plans? The firm has a 40 percent tax rate. (See Table 13.1)

A firm's capital structure is the mix of short-term liabilities and long-term debt.

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

If a firm's variable costs per unit increase,the firm's ________.

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

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, the firm's earnings per share will be ________.

The breakeven point in dollars can be computed by dividing the contribution margin into the variable operating costs.

The cost of equity is greater than the cost of debt and increases with increasing financial leverage, but generally less rapidly than the cost of debt.

In case of a manufacturing organization, which of the following is a variable cost that varies directly with the sales volume?

Firms having stable and predictable revenues can more safely employ highly leveraged capital structures than can firms with volatile patterns of sales revenue.

The asymmetric information explanation of capital structure suggests that firms will issue new equity only when the managers believe the firm's stock is overvalued; as a result, issuing new equity is considered a negative signal that will result in a decline in share price.