Question 1

The basic shortcoming of the EBIT-EPS approach to capital structure is ________.

Accepted Answer

A) that the optimal capital structure is difficult to compute 
B) its disregard for the presence of preferred stock in the capital structure 
C) its disregard for the firm's dividend policy 
D) that it concentrates on the maximization of EPS rather than the maximization of owner's wealth 
A) that the optimal capital structure is difficult to compute 
B) its disregard for the presence of preferred stock in the capital structure 
C) its disregard for the firm's dividend policy 
D) that it concentrates on the maximization of EPS rather than the maximization of owner's wealth

Question 2

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

Accepted Answer

A) True 
 B)False

Question 3

Which of the following is a difference between debt and equity capital?

Accepted Answer

A) Debt capital does not require periodic payments,whereas equity capital requires period payments. 
B) Debt capital requires returns in proportion to profits,whereas equity capital requires a fixed rate of return. 
C) Debt capital provides a tax shield,whereas equity capital does not provide a tax shield. 
D) Debt capital affects operating leverage,whereas equity capital affects financial leverage. 
A) Debt capital does not require periodic payments,whereas equity capital requires period payments. 
B) Debt capital requires returns in proportion to profits,whereas equity capital requires a fixed rate of return. 
C) Debt capital provides a tax shield,whereas equity capital does not provide a tax shield. 
D) Debt capital affects operating leverage,whereas equity capital affects financial leverage.

Question 4

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.

Accepted Answer

A) True 
 B)False

Question 5

________ is the risk reflected in fluctuations of a firm's cash flows because it uses debt or other fixed-cost financing.

Accepted Answer

A) Systematic risk 
B) Business risk 
C) Financial risk 
D) Diversifiable risk 
A) Systematic risk 
B) Business risk 
C) Financial risk 
D) Diversifiable risk

Question 6

The conflict resulting from a manager's desire to increase a firm's risk without increasing current borrowing costs and lenders' desire to limit lending is one effect of the ________ problem.

Accepted Answer

A) agency 
B) leverage 
C) capital 
D) variable cost 
A) agency 
B) leverage 
C) capital 
D) variable cost

Question 7

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

Accepted Answer

A) True 
 B)False

Question 8

Earnings before interest and taxes (EBIT)is a descriptive label for ________.

Accepted Answer

A) operating profits 
B) net profits before taxes 
C) earnings per share 
D) gross profits 
A) operating profits 
B) net profits before taxes 
C) earnings per share 
D) gross profits

Question 9

The dollar breakeven sales level can be solved for by dividing fixed costs by the contribution margin ratio.

Accepted Answer

A) True 
 B)False

Question 10

Operating leverage is concerned with the relationship between a firm's sales revenue and its financial expenses.

Accepted Answer

A) True 
 B)False

Question 11

In general,a firm's theoretical optimal capital structure is that which balances the tax benefits of debt financing against the increase probability of bankruptcy that result from its use.

Accepted Answer

A) True 
 B)False

Question 12

Asymmetric information results when managers of a firm have more information about the firm's operations and future prospects than investors have.

Accepted Answer

A) True 
 B)False

Question 13

A corporation has $10,000,000 of 10 percent preferred stock outstanding and a 21 percent tax rate.The amount of earnings before interest and taxes (EBIT)required to pay the preferred dividends is ________.

Accepted Answer

A) $1,000,000 
B) $210,000 
C) $790,000 
D) $1,265,823 
A) $1,000,000 
B) $210,000 
C) $790,000 
D) $1,265,823

Question 14

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.

Accepted Answer

A) True 
 B)False

Question 15

Beijing Berings is considering purchasing a small firm in the same line of business.The purchase would be financed by the sale of common stock or a bond issue.The financial manager needs to evaluate how the two alternative financing plans will affect the earnings potential of the firm.Total financing required is $4.5 million.The firm currently has $20,000,000 of 12 percent bonds and 600,000 common shares outstanding.The firm can arrange financing of the $4.5 million through a 14 percent bond issue or the sale of 100,000 shares of common stock.The firm has a 40 percent tax rate.
(a)What is the degree of financial leverage for each plan at $7,000,000 of EBIT?
(b)What is the financial breakeven point for each plan?

Accepted Answer

(a)DFL at base level EBIT (Bond Issue)=

Question 16

The probability that a firm will become bankrupt is largely dependent on its level of both business and financial risk.

Accepted Answer

A) True 
 B)False

Question 17

The more fixed cost financing a firm has in its capital structure,the greater is its financial leverage and risk.

Accepted Answer

A) True 
 B)False

Question 18

Which of the following is a reason why equity capital is considered riskier than debt capital?

Accepted Answer

A) Equity capital has a higher priority claim against assets and earnings. 
B) Equity capital requires regular periodic payments in the form of dividends. 
C) Equity capital expects dividend payments which are not tax-deductible. 
D) Equity capital remains invested in a firm indefinitely. 
A) Equity capital has a higher priority claim against assets and earnings. 
B) Equity capital requires regular periodic payments in the form of dividends. 
C) Equity capital expects dividend payments which are not tax-deductible. 
D) Equity capital remains invested in a firm indefinitely.

Question 19

In the EBIT-EPS approach to capital structure,risk is represented by ________.

Accepted Answer

A) the slope of the capital market line 
B) shifts in the cost of debt capital 
C) the slope of the capital structure line 
D) shifts in the times-interest-earned ratio 
A) the slope of the capital market line 
B) shifts in the cost of debt capital 
C) the slope of the capital structure line 
D) shifts in the times-interest-earned ratio

Question 20

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

Accepted Answer

A) True 
 B)False

The basic shortcoming of the EBIT-EPS approach to capital structure is ________.

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

Which of the following is a difference between debt and equity capital?

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.

________ is the risk reflected in fluctuations of a firm's cash flows because it uses debt or other fixed-cost financing.

The conflict resulting from a manager's desire to increase a firm's risk without increasing current borrowing costs and lenders' desire to limit lending is one effect of the ________ problem.

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

Earnings before interest and taxes (EBIT)is a descriptive label for ________.

The dollar breakeven sales level can be solved for by dividing fixed costs by the contribution margin ratio.

Operating leverage is concerned with the relationship between a firm's sales revenue and its financial expenses.

In general,a firm's theoretical optimal capital structure is that which balances the tax benefits of debt financing against the increase probability of bankruptcy that result from its use.

Asymmetric information results when managers of a firm have more information about the firm's operations and future prospects than investors have.

A corporation has $10,000,000 of 10 percent preferred stock outstanding and a 21 percent tax rate.The amount of earnings before interest and taxes (EBIT)required to pay the preferred dividends is ________.

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 probability that a firm will become bankrupt is largely dependent on its level of both business and financial risk.

The more fixed cost financing a firm has in its capital structure,the greater is its financial leverage and risk.

Which of the following is a reason why equity capital is considered riskier than debt capital?

In the EBIT-EPS approach to capital structure,risk is represented by ________.

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

The Role of Managerial Finance

The Financial Market Environment

Financial Statements and Ratio Analysis

Long- and Short-Term Financial Planning

Time Value of Money

Interest Rates and Bond Valuation

Stock Valuation

Risk and Return

The Cost of Capital

Capital Budgeting Techniques

Capital Budgeting Cash Flows and Risk Refinements

Payout Policy

Working Capital and Current Assets Management

Current Liabilities Management

Filters

Exam 12: Leverage and Capital Structure

The basic shortcoming of the EBIT-EPS approach to capital structure is ________.

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

Which of the following is a difference between debt and equity capital?

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.

________ is the risk reflected in fluctuations of a firm's cash flows because it uses debt or other fixed-cost financing.

The conflict resulting from a manager's desire to increase a firm's risk without increasing current borrowing costs and lenders' desire to limit lending is one effect of the ________ problem.

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

Earnings before interest and taxes (EBIT)is a descriptive label for ________.

The dollar breakeven sales level can be solved for by dividing fixed costs by the contribution margin ratio.

Operating leverage is concerned with the relationship between a firm's sales revenue and its financial expenses.

In general,a firm's theoretical optimal capital structure is that which balances the tax benefits of debt financing against the increase probability of bankruptcy that result from its use.

Asymmetric information results when managers of a firm have more information about the firm's operations and future prospects than investors have.

A corporation has $10,000,000 of 10 percent preferred stock outstanding and a 21 percent tax rate.The amount of earnings before interest and taxes (EBIT)required to pay the preferred dividends is ________.

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 probability that a firm will become bankrupt is largely dependent on its level of both business and financial risk.

The more fixed cost financing a firm has in its capital structure,the greater is its financial leverage and risk.

Which of the following is a reason why equity capital is considered riskier than debt capital?

In the EBIT-EPS approach to capital structure,risk is represented by ________.

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

The Role of Managerial Finance

The Financial Market Environment

Financial Statements and Ratio Analysis

Long- and Short-Term Financial Planning

Time Value of Money

Interest Rates and Bond Valuation

Stock Valuation

Risk and Return

The Cost of Capital

Capital Budgeting Techniques

Capital Budgeting Cash Flows and Risk Refinements

Payout Policy

Working Capital and Current Assets Management

Current Liabilities Management

Filters