Exam 12: Leverage and Capital Structure

Debt is a relatively inexpensive source of capital because lenders take the least risk among the long-term contributors of capital.

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

A firm has fixed operating costs of $10,000,the sale price per unit of its product is $25,and its variable cost per unit is $15.The firm's operating breakeven point in units is ________ and its breakeven point in dollars is ________.

________ costs require the payment of a specified amount in each accounting period.

Mark must buy four new tires for his car.He is considering buying tires that are $25 a piece more than his regular brand,because the higher priced tires are supposed to increase his miles per gallon by 20%.If the tires are good for 48,000 miles and Mark drives an average of 1,000 miles per month,gas costs $2.50 per gallon over the next 4 years,and Mark's car gets 30 miles to the gallon now (on the old tires),should Mark purchase the more expensive tires?

A firm's ________ is the level of sales necessary to cover all operating costs,i.e.,the point at which EBIT equals zero.

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

Optimal capital structure is the capital structure at which the weighted average cost of capital is minimized,thereby maximizing a firm's value.

The 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.

Poor capital structure decisions can result in a high cost of capital,thereby making some unacceptable investments acceptable.

A firm has a current capital structure consisting of $400,000 of 6 percent annual interest debt and 50,000 shares of common stock.The firm's tax rate is 21 percent on ordinary income.If the EBIT is expected to be $200,000,the firm's earnings per share will be ________.

The base level of EBIT must be held constant to compare the financial leverage associated with different levels of fixed financial costs.

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

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

Because of the extensive research conducted in recent years in the area of capital structure theory,it is now possible for financial managers to pinpoint with great accuracy a firm's optimal capital structure.

A corporation has $5,000,000 of 8 percent preferred stock outstanding and a 21 percent tax rate.The after-tax cost of the preferred stock is ________.

The EBIT-EPS approach to capital structure involves selecting the capital structure that maximizes earnings before interest and taxes (EBIT)over the expected range of earnings per share (EPS).

Minimizing the weighted average cost of capital allows management to undertake a larger number of profitable projects,thereby further increasing the value of a firm.

Poor capital structure decisions can result in ________ the cost of capital,resulting in ________ acceptable investments.

A firm has fixed operating costs of $175,000,total sales revenue of $3,000,000 and total variable costs of $2,250,000.The firm's degree of operating leverage is ________.