Exam 12: Leverage and Capital Structure

The key differences between debt and equity capital include all of the following EXCEPT

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

Breakeven analysis is used by the firm

Both operating and financial leverage result in the magnification of return as well as 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.

The firm's ________ is the mix of long-term debt and equity utilized by the firm, which may significantly affect its value by affecting return and risk.

Operating leverage results from the existence of operating costs in the firm's income stream.

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.

Financial leverage is concerned with the relationship between the firm's earnings after interest and taxes and its common stock earnings per share.

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

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.

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

Operating leverage may be defined as the potential use of fixed operating costs to magnify the effects of changes in sales on the firm's earnings before interest and taxes (EBIT).

Generally, ________ in leverage result in ________ return and ________ risk.

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

________ leverage is concerned with the relationship between earnings before interest and taxes and earnings per share.

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

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

A firm has EBIT of $375,000, interest expense of $75,000, preferred dividends of $6,000 and a tax rate of 40 percent. The firm's degree of financial leverage at a base EBIT level of $375,000 is ________.

While operating leverage results only in a magnification of returns, financial leverage results only in a magnification of risk.