Exam 13: Leverage and Capital Structure

A firm is analyzing two possible capital structures-30 and 50 percent debt ratios. The firm has total assets of $5,000,000 and common stock valued at $50 per share. The firm has a marginal tax rate of 40 percent on ordinary income. If the interest rate on debt is 7 percent and 9 percent for the 30 percent and the 50 percent debt ratios, respectively, the amount of interest on the debt under each of the capital structures being considered would be ________.

While operating leverage results only in a magnification of returns, financial leverage results only in a magnification of risk.

________ results from the use of fixed-cost assets or funds to magnify returns to a firm's owners.

________ leverage is concerned with the relationship between sales revenues and earnings before interest and taxes.

Which of the following is the correct order in which corporations generally raise funds to enhance the wealth of stockholders and to send positive signals to the market?

Harry Trading Company must choose its optimal capital structure. Currently, the firm has a 20 percent debt ratio and the firm expects to generate a dividend next year of $5.44 per share. Dividends are expected to remain at this level indefinitely. Stockholders currently require a 12.1 percent return on their investment. Harry is considering changing its capital structure if it would benefit shareholders. The firm estimates that if it increases the debt ratio to 30 percent, it will increase its expected dividend to $5.82 per share. Again, dividends are expected to remain at this new level indefinitely. However, because of the added risk, the required return demanded by stockholders will increase to 12.6 percent. Based on this information, should Harry make the change?

Higher financial leverage causes ________ to increase more for a given increase in ________.

With the existence of fixed operating costs, an increase in sales will result in ________ increase in EBIT.

Asymmetric information results when managers of a firm have more information about the firm's operations and future prospects than investors have.

A firm is analyzing two possible capital structures-30 and 50 percent debt ratios. The firm has total assets of $5,000,000 and common stock valued at $50 per share. The firm has a marginal tax rate of 40 percent on ordinary income. The number of common shares outstanding for each of the capital structures would be ________.

The probability that a firm will become bankrupt is largely dependent on its level of both business and financial risk.

Which of the following is a reason why equity capital is considered riskier than debt capital?

A major assumption of breakeven analysis and one which causes severe limitations in its use is that ________.

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

Whenever the percentage change in earnings before interest and taxes resulting from a given percentage change in sales is greater than the percentage change in sales, operating leverage exists.

Operating leverage measures the effect of fixed operating costs on the relationship between ________.

The value of a firm at optimum capital structure is computed as ________.

If a firm's fixed operating costs decrease, the firm's ________.

For sales levels below the operating breakeven point, sales revenue exceeds total operating costs, and earnings before interest and taxes is greater than zero.

The use of a dollar breakeven point is important when a firm has more than one product, especially when each product is selling at a different price.