Exam 12: 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.

Because the degree of total leverage is multiplicative and not additive,when a firm has very high operating leverage it can moderate its total risk by ________.

Tangshan Mining Company must choose its optimal capital structure.Currently,the firm has a 40 percent debt ratio and the firm expects to generate a dividend next year of $4.89 per share and dividends are expected to grow at a constant rate of 5 percent for the foreseeable future.Stockholders currently require a 10.89 percent return on their investment.Tangshan Mining is considering changing its capital structure if it would benefit shareholders.The firm estimates that if it increases the debt ratio to 50 percent,it will increase its expected dividend to $5.24 per share.Because of the additional leverage,dividend growth is expected to increase to 6 percent and this growth will be sustained indefinitely.However,because of the added risk,the required return demanded by stockholders will increase to 11.34 percent. (a)What is the value per share for Tangshan Mining under the current capital structure? (b)What is the value per share for Tangshan Mining under the proposed capital structure? (c)Should Tangshan Mining make the capital structure change? Explain.

In general,a low times interest earned ratio and a low fixed-payment coverage ratio are associated with a high degree of financial leverage.

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

Fixed financial charges include ________.

A firm has interest expense of $145,000,preferred dividends of $25,000,and a tax rate of 21 percent.The firm's financial breakeven point is ________.

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

As debt is substituted for equity in the capital structure and the debt ratio increases,the behavior of the overall cost of capital is partially explained by ________.

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

The total leverage measures the combined effect of operating and financial leverage on a firm's risk.

The three basic types of leverage are ________.

The overriding objective of the capital structure decision should be to choose the level of debt that results in the largest possible share price.

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.

Despite the extensive research conducted in recent years in the area of capital structure theory,it is not yet possible to provide financial managers with a specified methodology for use in determining a firm's optimal capital structure.

Table 13.1 -At about what EBIT level should the financial manager be indifferent to either plan? (See Table 13.1)

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.

The contribution margin is defined as the percent of each sales dollar that remains after satisfying fixed operating costs.

A firm's operating breakeven point is the point at which ________.

A corporation has $5,000,000 of 6 percent bonds and $9,600,000 of 5 percent preferred stock outstanding.The firm's financial breakeven (assuming a 21 percent tax rate)is ________.