Exam 12: Leverage and Capital Structure

The EBIT-EPS analysis tends to concentrate on maximization of earnings rather than maximization of owners' wealth.

The cost of equity increases with increasing financial leverage in order to compensate the stockholders for the higher degree of financial risk.

The effect of financial leverage is such that an increase in a firm's earnings before interest and taxes (EBIT)results in a more than proportional increase in the firm's earnings per share (EPS),while a decrease in the firm's EBIT results in a less than proportional decrease in EPS.

Table 12.1 -Assuming a 40 percent tax rate,what is the financial breakeven point for each plan? (See Table 12.1)

________ analysis is a technique used to assess the returns associated with various cost structures and levels of sales.

If we assume that EBIT is constant,the value of a firm is maximized by minimizing the weighted average cost of capital.

The higher the degree of financial leverage (DFL),the greater the leverage a given financing plan has,and the steeper its slope when plotted on EBIT-EPS axes.

Which of the following is true of leverage?

A firm's ________ is the level of sales necessary to cover all operating costs,i.e.,the point at which EBIT equals zero.

Optimal capital structure is the capital structure at which the weighted average cost of capital is minimized,thereby maximizing a firm's value.

Table 12.1 -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 12.1)

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

The higher the financial breakeven point and the steeper the slope of the capital structure line,the greater the financial risk.

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.

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?

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

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?

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

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

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