Exam 13: Leverage and Capital Structure

When a firm has fixed operating costs, operating leverage is present. In that case, an increase in sales results in a more-than-proportional increase in EBIT, and a decrease in sales results in a more-than-proportional decrease in EBIT.

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.

The risk of the debt capital is less than that of other long-term contributors of capital because

If a firm's sale price per unit decreases, the firm's operating breakeven point will

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 the firm's earnings per share (EPS).

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

Business risk is the risk to the firm of being unable to cover required financial obligations.

When considering fixed operating cost increases, the financial manager must weigh the increased financial risk associated with greater operating leverage against the expected increase in returns.

Because risk premiums increase with increases in financial leverage, maximizing EPS does not assure owners' wealth maximization.

The firm's ________ is the level of sales necessary to cover all operating costs, i.e., the point at which EBIT = $0.

The three basic types of leverage are

Operating leverage measures the effect of fixed financing costs on the relationship between

An increase in fixed operating costs will result in ________ in the degree of operating leverage.

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.

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.

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.

The optimal capital structure is the one that balances

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

The controversy over the existence of an optimal capital structure is debated between those ________ who believe a traditional approach exists and those ________, who do not believe one exists. In the ________ approach to capital structure, the optimal capital structure occurs where the ________ is minimized.

The degree of operating leverage will increase if a firm decides to compensate its sales representatives with a fixed salary and bonus rather than with a pure percent-of-sales commission.