Exam 12: Leverage and Capital Structure

Financial breakeven point represents the level of earnings after interest and taxes necessary for a firm to cover its fixed operating and financial changes-that is,the point at which dividends per share is equal to zero.

As fixed operating costs increase and all other factors are held constant,________.

The closer the base sales level used is to the operating breakeven point,the smaller the operating leverage.

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

In finding the operating breakeven point,it is important to divide the cost of goods sold and operating expenses into fixed and variable operating costs.

Total leverage is concerned with the relationship between a firm's sales revenue and its common stock earnings per share.

________ is the risk of being unable to cover financial obligations of a firm.

The operating breakeven point can be found by solving for the sales level that just covers total fixed and variable costs.

The steeper the slope of the EBIT-EPS capital structure line,the lower is the financial risk.

Breakeven analysis is used by a firm to determine the level of operations necessary to cover all fixed operating costs and to evaluate the profitability associated with various levels of production.

A firm has fixed operating costs of $650,000,a sales price per unit of $20,and a variable cost per unit of $13.At a base sales level of 500,000 units,the firm's degree of operating leverage is ________.

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?

China America Manufacturing is evaluating two different operating structures which are described below.The firm has annual interest expense of $250,common shares outstanding of 1,000,and a tax rate of 40 percent. (a)For each operating structure,calculate (a1)EBIT and EPS at 10,000,20,000,and 30,000 units. (a2)the degree of operating leverage (DOL)and degree of total leverage (DTL)using 20,000 units as a base sales level. (a3)the operating breakeven point in units. (b)Which operating structure has greater operating leverage and business risk? (c)If China America projects sales of 20,000 units,which operating structure is recommended?

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 ________.

Financial leverage may be defined as the potential use of variable financial costs to magnify the effects of changes in earnings before interest and taxes (EBIT)on a firm's earnings per share (EPS).

Tony's Beach T-Shirts has fixed annual operating costs of $75,000.Tony retails his T-shirts for $14.99 each and the variable cost per T-shirt is $4.99.Based on this information,the breakeven sales level in dollars is ________.

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

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

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

Which of the following affects business risk?