Question 1

Comparison of the degree of operating leverage of two firms is valid only when the base level of sales used for each firm is the same.

Accepted Answer

A) True 
 B)False

Question 2

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.

Accepted Answer

A)  agency 
B)  leverage 
C)  capital 
D)  variable cost 
A)  agency 
B)  leverage 
C)  capital 
D)  variable cost

Question 3

Frankline Coin,Inc.is considering two capital structures.The key information follows.Assume a 40 percent tax rate and expected EBIT of $50,000.   (a)Calculate two EBIT-EPS coordinates for each of the structures.
(b)Indicate over what EBIT range,if any,each structure is preferred.

Accepted Answer

(a) @#IMG-DLM& (b)Calculation of indifference poin

Question 4

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.

Accepted Answer

A) True 
 B)False

Question 5

Mark must buy four new tires for his car.He is considering buying tires that are $25 a piece more than his regular brand,because the higher priced tires are supposed to increase his miles per gallon by 20%.If the tires are good for 48,000 miles and Mark drives an average of 1,000 miles per month,gas costs $2.50 per gallon over the next 4 years,and Mark's car gets 30 miles to the gallon now (on the old tires),should Mark purchase the more expensive tires?

Accepted Answer

A)  Yes, because Mark will save about $660 dollars in gas over the four years but the new tires will only be $100 more. 
B)  Yes, because Mark will save about $560 dollars in gas over the four years but the new tires will only be $100 more. 
C)  No, because Mark will only save about $60 dollars in gas over the four years but the new tires will only be $100 more. 
D)  No, because Mark will only save about $90 dollars in gas over the four years but the new tires will only be $100 more. 
A)  Yes, because Mark will save about $660 dollars in gas over the four years but the new tires will only be $100 more. 
B)  Yes, because Mark will save about $560 dollars in gas over the four years but the new tires will only be $100 more. 
C)  No, because Mark will only save about $60 dollars in gas over the four years but the new tires will only be $100 more. 
D)  No, because Mark will only save about $90 dollars in gas over the four years but the new tires will only be $100 more.

Question 6

Total leverage exists 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.

Accepted Answer

A) True 
 B)False

Question 7

Beijing Bearings 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?

Accepted Answer

(a)DFL at base level EBIT (Bond Issue)=

Question 8

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 ________.

Accepted Answer

A)  $40,000 
B)  $60,000 
C)  $100,000 
D)  $166,667 
A)  $40,000 
B)  $60,000 
C)  $100,000 
D)  $166,667

Question 9

The cost of debt financing results from ________.

Accepted Answer

A)  the decreased probability of bankruptcy caused by debt obligations 
B)  the risk-return trade-off associated with ownership of a firm 
C)  the costs associated with lenders having less information about a firm's prospects than investors and managers 
D)  the agency costs of the lenders' monitoring and controlling a firm's actions 
A)  the decreased probability of bankruptcy caused by debt obligations 
B)  the risk-return trade-off associated with ownership of a firm 
C)  the costs associated with lenders having less information about a firm's prospects than investors and managers 
D)  the agency costs of the lenders' monitoring and controlling a firm's actions

Question 10

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

Accepted Answer

A)  earnings before interest and taxes times one less tax rate divided by one plus weighted average cost of capital 
B)  earnings before interest and taxes times one less tax rate divided by weighted average cost of capital 
C)  operating cash flow divided by weighted average cost of capital 
D)  operating cash flow divided by one plus weighted average cost of capital 
A)  earnings before interest and taxes times one less tax rate divided by one plus weighted average cost of capital 
B)  earnings before interest and taxes times one less tax rate divided by weighted average cost of capital 
C)  operating cash flow divided by weighted average cost of capital 
D)  operating cash flow divided by one plus weighted average cost of capital

Question 11

________ leverage measures the effect of fixed ________ costs on the relationship between EBIT and EPS.

Accepted Answer

A)  Operating; operating 
B)  Financial; financial 
C)  Operating; financial 
D)  Financial; operating 
A)  Operating; operating 
B)  Financial; financial 
C)  Operating; financial 
D)  Financial; operating

Question 12

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.

Accepted Answer

A) True 
 B)False

Question 13

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

Accepted Answer

A)  Equity capital has a higher priority claim against assets and earnings. 
B)  Equity capital requires regular periodic payments in the form of dividends. 
C)  Equity capital expects dividend payments which are not tax-deductible. 
D)  Equity capital remains invested in a firm indefinitely. 
A)  Equity capital has a higher priority claim against assets and earnings. 
B)  Equity capital requires regular periodic payments in the form of dividends. 
C)  Equity capital expects dividend payments which are not tax-deductible. 
D)  Equity capital remains invested in a firm indefinitely.

Question 14

Bamboo manufacturing sells its finished product for an average of $35 per unit with a variable cost per unit of $21.The company has fixed operating costs of $1,050,000.
(a)Calculate the firm's operating breakeven point in units.
(b)Calculate the firm's operating breakeven point in dollars.
(c)Using 100,000 units as a base,what is the firm's degree of operating leverage?

Accepted Answer

(a)Q = @#IMG-DLM& = @#IMG-DLM& = 75,000 units
(b)D

Question 15

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

Accepted Answer

A) True 
 B)False

Question 16

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

Accepted Answer

A) True 
 B)False

Question 17

Operating leverage is present when a firm has fixed operating costs.

Accepted Answer

A) True 
 B)False

Question 18

Generally,decreases in leverage result in increased return and risk,whereas increases in leverage result in decreased return and risk.

Accepted Answer

A) True 
 B)False

Question 19

Breakeven analysis is used by a firm ________.

Accepted Answer

A)  to determine the level of operations necessary to cover all fixed operating costs 
B)  to determine the least cost of producing goods and services 
C)  to evaluate the profitability associated with various levels of sales 
D)  to determine the demand of a product 
A)  to determine the level of operations necessary to cover all fixed operating costs 
B)  to determine the least cost of producing goods and services 
C)  to evaluate the profitability associated with various levels of sales 
D)  to determine the demand of a product

Question 20

As financial leverage increases,the cost of debt initially remains constant and then rises,while the cost of equity always rises.

Accepted Answer

A) True 
 B)False

Comparison of the degree of operating leverage of two firms is valid only when the base level of sales used for each firm is the same.

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.

Frankline Coin,Inc.is considering two capital structures.The key information follows.Assume a 40 percent tax rate and expected EBIT of $50,000. (a)Calculate two EBIT-EPS coordinates for each of the structures. (b)Indicate over what EBIT range,if any,each structure is preferred.

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.

Total leverage exists 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.

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 ________.

The cost of debt financing results from ________.

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

leverage measures the effect of fixed costs on the relationship between EBIT and EPS.

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.

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

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

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

Operating leverage is present when a firm has fixed operating costs.

Generally,decreases in leverage result in increased return and risk,whereas increases in leverage result in decreased return and risk.

Breakeven analysis is used by a firm ________.

As financial leverage increases,the cost of debt initially remains constant and then rises,while the cost of equity always rises.

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 and Risk Refinements

Payout Policy

Working Capital and Current Assets Management

Current Liabilities Management

Filters

Exam 12: Leverage and Capital Structure

Comparison of the degree of operating leverage of two firms is valid only when the base level of sales used for each firm is the same.

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.

Frankline Coin,Inc.is considering two capital structures.The key information follows.Assume a 40 percent tax rate and expected EBIT of $50,000. (a)Calculate two EBIT-EPS coordinates for each of the structures. (b)Indicate over what EBIT range,if any,each structure is preferred.

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.

Total leverage exists 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.

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 ________.

The cost of debt financing results from ________.

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

________ leverage measures the effect of fixed ________ costs on the relationship between EBIT and EPS.

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.

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

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

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

Operating leverage is present when a firm has fixed operating costs.

Generally,decreases in leverage result in increased return and risk,whereas increases in leverage result in decreased return and risk.

Breakeven analysis is used by a firm ________.

As financial leverage increases,the cost of debt initially remains constant and then rises,while the cost of equity always rises.

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 and Risk Refinements

Payout Policy

Working Capital and Current Assets Management

Current Liabilities Management

Filters

leverage measures the effect of fixed costs on the relationship between EBIT and EPS.