Exam 12: Leverage and Capital Structure

Since the sales price per unit generally decreases with volume and the cost per unit generally increases with volume,the true breakeven point may be different from those obtained using linear revenue and cost functions as assumed in the breakeven analysis.

Total leverage can be defined as the potential use of fixed costs,both operating and financial,to magnify the effect of changes in sales on a firm's earnings per share.

Operating leverage is defined as the use of fixed operating costs to magnify the effects of changes in sales on a firm's earnings before interest and taxes.

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

A firm's capital structure is the mix of the current liabilities,long-term debt,and equity maintained by the firm.

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

The basic shortcoming of EBIT-EPS analysis is that this model focuses on the maximization of earnings rather than on the maximization of owner wealth as reflected in a firm's stock price.

In theory,a firm's optimal capital structure is that which minimized the firm's overall cost of capital resulting in a maximization of the market value of a firm.

In general,the greater a firm's operating leverage,the higher its business risk.

Which of the following is a basic source of capital for a firm?

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 pecking order explanation of capital structure states that a hierarchy of financing exists for firms,in which retained earnings are employed first,followed by debt financing and finally by external equity financing.

Due to the difficulty of allocating costs to products in a multiproduct firm,the breakeven model may fail to determine breakeven points for each product line.

Table 12.1 -What is the EPS under Financing Plan 1,if the firm projects EBIT of $200,000 and has a tax rate of 40 percent? (See Table 12.1)

A corporation has $5,000,000 of 10 percent bonds and $3,000,000 of 12 percent preferred stock outstanding.The firm's financial breakeven (assuming a 40 percent tax rate)is ________.

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 ________.

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

In general,a firm's theoretical optimal capital structure is that which balances the tax benefits of debt financing against the increase probability of bankruptcy that result from its use.

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

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