Exam 13: Leverage and Capital Structure

A major assumption of breakeven analysis and one which causes severe limitations in its use is that

If a firm's variable costs per unit increase, the firm's operating breakeven point will

Noncash charges such as depreciation and amortization ________ the firm's breakeven point.

A firm is analyzing two possible capital structures 30 and 50 percent debt ratios. The firm has total assets of $5,000,000 and common stock valued at $50 per share. The firm has a marginal tax rate of 40 percent on ordinary income. If the interest rate on debt is 7 percent and 9 percent for the 30 percent and the 50 percent debt ratios, respectively, the amount of interest on the debt under each of the capital structures being considered would be

Financial leverage results from the presence of variable financial costs in the firm's income stream.

As debt is substituted for equity in the capital structure and the debt ratio increases, all of the following statements about the component costs of capital are true EXCEPT

The major shortcoming of the EBIT-EPS approach to capital structure is that

________ risk is the risk of being unable to cover operating costs.

As fixed operating costs increase and all other factors are held constant, the degree of operating leverage will

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

The degree of operating leverage depends on the base level of sales used as a point of reference. The closer the base sales level used is to the operating breakeven point, the greater the operating leverage.

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

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 decrease in fixed operating costs will result in ________ in the degree of financial leverage.

A corporation has $10,000,000 of 10 percent preferred stock outstanding and a 40 percent tax rate. The amount of earnings before interest and taxes (EBIT) required to pay the preferred dividends is

________ risk is the risk of being unable to cover financial costs.

A firm has fixed operating costs of $25,000, a per unit sales price of $5, and a variable cost per unit of $3. What is its operating breakeven point if it desires net operating income of $10,000, not $0 (zero)?

________ costs are a function of volume, not time.

Earnings before interest and taxes are positive above the operating breakeven point, and a loss occurs below it.