Deck 5: Operating and Financial Leverage

Question 1

Operating leverage works best when volume is increasing.

Answer 1

True

Question 2

A lower price for the firm's product will reduce the firm's break-even point.

Answer 2

False

Question 3

The degree of operating leverage is a number indicating the relationship between the percentage change in sales to the percentage change in earnings per share.

Answer 3

False

Question 4

The contribution margin is equal to sales price per unit minus total costs per unit.

Question 5

Operating leverage determines how income from operations is to be divided between debt holders and stockholders.

Question 6

Sales commissions and raw materials are variable costs.

Question 7

Management should tailor the use of leverage to meet its own risk-taking desires.

Question 8

Property taxes and depreciation expense are examples of variable costs.

Question 9

Operating leverage will change when a firm alters the mix of fixed capital resources and variable labor that it uses.

Question 10

The closer a firm is to its break-even point, the lower the degree of operating leverage it will be.

Question 11

As the contribution margin rises, the break-even point goes down.

Question 12

Operating leverage emphasizes the impact of using fixed assets in the business.

Question 13

Managers who are risk-averse and uncertain about the future would most likely minimize combined leverage.

Question 14

For firms in industries that offer some degree of stability, are in a positive stage of growth, and are operating in favorable economic conditions, the use of debt is not needed or recommended.

Question 15

"Operating leverage" is the use of fixed costs to magnify returns at high levels of operation.

Question 16

Financial leverage emphasizes the impact of using debt in the business.

Question 17

If economic conditions were expected to be favorable, an investor would likely prefer a firm with a low degree of leverage.

Question 18

Use of financial leverage must consider risk, not just maximizing profit.

Question 19

Cash break-even analysis eliminates the depreciation expense and other non-cash charges from fixed costs.

Question 20

Contribution margin is equal to fixed costs minus variable costs.

Question 21

The degree of financial leverage measures the percentage change in EPS for every 1% move in EBIT.

Question 22

Degree of combined leverage considers the impact of a change in volume on the change in operating income.

Question 23

Operating income is not the same thing as EBIT.

Question 24

An example of an adjustment for a cash break-even analysis would be adding back increases in accounts receivable.

Question 25

Linear break-even analysis assumes that costs are linear functions of volume.

Question 26

A firm with a high degree of financial leverage could face financial difficulty even though it is in a stable industry.

Question 27

For Japanese firms that have high levels of operating and financial leverage, maintaining sales volume is of critical importance even at the cost of price.

Question 28

Degree of operating leverage should be computed only over a profitable range of operations.

Question 29

The degree of combined leverage is the sum of the degree of operating leverage and the degree of financial leverage.

Question 30

Operating leverage primarily affects the left-hand side of the balance sheet, while financial leverage affects the right-hand side of the balance sheet.

Question 31

The degree of financial leverage is not influenced by the interest rate on debt, only the amount borrowed.

Question 32

Financial leverage breakeven occurs when return on total assets is equal to the cost of borrowed funds.

Question 33

Operating leverage influences the bottom half of the income statement while financial leverage deals with the top half.

Question 34

Firms with cyclical sales should employ a high degree of leverage.

Question 35

In order to conduct a cash break-even analysis, the analyst must add back depreciation from fixed costs.

Question 36

A firm with a high degree of combined leverage will, other things being equal, experience higher earnings in the expansionary part of the business cycle.

Question 37

The interwoven boundaries of banks and different trading companies in Japan make it easier to acquire credit in Japan than in the U.S.

Question 38

If a firm has a DFL of 2.0, EPS will change 2% for every 1% change in volume.

Question 39

Linear break-even analysis and operating leverage are only valid within a relevant range of production.

Question 40

Financial leverage primarily affects the left-hand side of the balance sheet.

Question 41

If a firm has fixed costs of $60,000, a price of $7.00, and a break-even point of 25,000 units, the variable cost per unit is _____.

A)$5.00
B)$4.60
C)$5.40
D)$4.00

Question 42

Which of the following questions does break-even analysis attempt to address?

A)How much do changes in volume affect costs and profits?
B)At what point does the firm break even?
C)What is the most efficient level of fixed assets to employ?
D)All of the options

Question 43

If a firm has a price of $6.00, a variable cost per unit of $4.00, and a break-even point of 40,000 units, fixed costs are equal to _____.

A)$27,000
B)$90,000
C)$80,000
D)$50,000

Question 44

A firm's break-even point will rise if

A)fixed costs decrease.
B)contribution margin increases.
C)price per unit rises.
D)variable cost per unit rises.

Question 45

The break-even point can be calculated as

A)variable costs divided by contribution margin per unit.
B)total costs divided by contribution margin per unit.
C)variable costs times contribution margin per unit.
D)fixed costs divided by contribution margin per unit.

Question 46

A weakness of break-even analysis is that it assumes

A)revenue and costs are a linear (constant) function of volume.
B)prices and costs increase when the economy is strong and confidence is high.
C)the cost of goods sold goes up as revenue increases.
D)None of the options

Question 47

If a firm sells 40,000 units and the contribution margin on the firm's single product is $4.00 per unit and fixed costs are $60,000, what will the firm's operating profit be at this level of sales volume?

A)$100,000
B)$30,000
C)$15,000
D)$145,000

Question 48

A firm has operating profit of $15,000 on unit sales of 10,000 units. Fixed costs are $30,000. What is the firm's break-even sales level?

A)Less than 6,000 units.
B)6,000 units.
C)More than 6,000 units
D)There is not enough information to determine the unit break-even point.

Question 49

A highly automated plant would generally have

A)more variable than fixed costs.
B)more fixed than variable costs.
C)all fixed costs.
D)all variable costs.

Question 50

Davison Toaster Corp. sells its products for $150 per unit. It has the following costs: $$\begin{array} { l l } \text { Rent } & \$ 115,000 \\\text { Factory labor } & \$ 20 \text { per unit } \\\text { Executive salaries } & \$ 200,000 \\\text { Raw materials } & \$ 6 \text { per unit }\end{array}$$ The break-even point is

A)less than 3,000 units.
B)3,000 units.
C)more than 3,500 units.
D)Not enough information has been provided to determine the break-even point.

Question 51

In break-even analysis, the contribution margin is defined as

A)price minus variable cost.
B)price minus fixed cost.
C)variable cost minus fixed cost.
D)fixed cost minus variable cost.

Question 52

If sales volume exceeds the break-even point, the firm will experience

A)an operating loss.
B)an operating profit.
C)an increase in plant and equipment.
D)an increase in stock price.

Question 53

Increasing financial leverage will always lead to higher EPS because it reduces the number of shares outstanding.

Question 54

If a firm has fixed costs of $30,000, a variable cost per unit of $.75, and a break-even point of 5,000 units, the price is _____.

A)$2.50
B)$6.75
C)$4.00
D)$4.50

Question 55

The concept of operating leverage involves the use of __________ to magnify returns at high levels of operation.

A)fixed costs
B)variable costs
C)marginal costs
D)semi-variable costs

Question 56

If the price per unit decreases because of competition but the cost structure remains the same

A)the break-even point rises.
B)the degree of combined leverage declines.
C)the degree of financial leverage declines.
D)All of the options

Question 57

At the break-even point, a firm's profits are

A)greater than zero.
B)less than zero.
C)equal to zero.
D)Not enough information is given to determine.

Question 58

If fixed costs rise while other variables stay constant

A)the break-even point rises.
B)the degree of operating leverage increases.
C)total profit declines.
D)All of the options

Question 59

If a firm with $49,000 in fixed costs breaks even on unit sales of 7,000, how many units must the firm sell to earn $30,000 in operating profit?

A)30,000 units
B)11,286 units
C)15,824 units
D)There is not enough information to determine the unit sales required

Question 60

Which of the following is true about the concept of leverage?

A)At the break-even point, operating leverage is equal to zero.
B)Combined leverage measures the impact of operating and financial leverage on EBIT.
C)Financial leverage measures the impact of fixed costs on earnings.
D)None of the options

Question 61

Which of the following is not true about leverage?

A)Operating leverage influences the top half of the income statement, determining EBIT.
B)Financial leverage deals with the bottom half of the income statement, determining EPS.
C)Combined leverage utilizes the entire income statement, showing the impact of change in volume on EBIT.
D)None of the options

Question 62

When a firm employs no debt

A)it has a financial leverage of one.
B)it has a financial leverage of zero.
C)its operating leverage is equal to its financial leverage.
D)it will not be profitable.

Question 63

Under which of the following conditions could the overuse of financial leverage be detrimental to the firm?

A)In a stable industry.
B)When there is cyclical demand for the firm's products.
C)During an upswing in the business cycle.
D)When there is low interest cost compared to return on assets.

Question 64

Which of the following is concerned with the change in operating profit as a result of a change in volume?

A)Financial leverage
B)Break-even point
C)Operating leverage
D)Combined leverage

Question 65

The degree of operating leverage may be defined as

A)the percent change in operating income divided by the percent change in unit volume.
B)Q(P - VC) divided by Q(P - VC) - FC.
C)S - TVC divided by S - TVC - FC.
D)All of the options

Question 66

Heavy use of long-term debt may be beneficial in an inflationary economy because

A)the debt may be repaid in more "expensive" dollars.
B)nominal interest rates exceed real interest rates.
C)inflation is associated with the peak of a business cycle.
D)the debt may be repaid in "cheaper" dollars.

Question 67

A conservative financing plan involves

A)heavy reliance on debt.
B)heavy reliance on equity.
C)a high degree of financial leverage.
D)a high degree of combined leverage.

Question 68

A firm's earnings per share is not impacted by its financing plan at the point when

A)debt is equal to equity.
B)return on assets equals return on equity.
C)the cost of borrowed funds equals the return on equity.
D)the cost of borrowed funds equals the return on assets.

Question 69

Combined leverage is concerned with the relationship between

A)changes in EBIT and changes in EPS.
B)changes in volume and changes in EPS.
C)changes in volume and changes in EBIT.
D)changes in EBIT and changes in net income.

Question 70

The degree of operating leverage is computed as

A)percent change in operating profit divided by percent change in net income.
B)percent change in unit volume divided by percent change in operating profit.
C)percent change in EPS divided by percent change in operating income.
D)percent change in operating income divided by percent change in unit volume.

Question 71

Cash break-even analysis

A)is helpful in analyzing the short-term outlook of the firm, particularly when it is in trouble financially.
B)is important when analyzing long-term profitability.
C)includes depreciation expense as a fixed cost when calculating the degree of financial leverage.
D)None of the options

Question 72

Firms with a high degree of operating leverage are

A)easily capable of surviving large changes in sales volume.
B)usually trading off lower levels of risk for higher profits.
C)significantly affected by changes in interest rates.
D)trading off higher fixed costs for lower per-unit variable costs.

Question 73

Firm A produces semiconductors using highly technical machinery; Firm B is a retail clothing store. Consider which firm employs a higher degree of operating leverage and then answer the following question: "Which of the following comparative statements about firms A and B is true?"

A)A has a lower break-even point than B, but A's profit grows faster after the breakeven.
B)A has a higher break-even point than B, but A's profit grows slower after the breakeven.
C)B has a lower break-even point than A, but A's profit grows faster after the breakeven.
D)B has a lower break-even point than A, and profit grows at the same rate for both companies after the break-even point.

Question 74

Firm A employs a high degree of operating leverage; Firm B takes a more conservative approach. Which of the following comparative statements about firms A and B is true?

A)A has a lower break-even point than B, but A's profit grows faster after the breakeven.
B)A has a higher break-even point than B, but A's profit grows slower after the breakeven.
C)B has a lower break-even point than A, but A's profit grows faster after the breakeven.
D)B has a lower break-even point than A, and profit grows the same rate for both companies after the break-even point.

Question 75

Financial leverage deals with

A)the relationship of fixed and variable costs.
B)the relationship of debt and equity in the capital structure.
C)the entire income statement.
D)the entire balance sheet.

Question 76

Loretta & Niece's fixed costs are $425,000, including $25,000 of depreciation expense. The price of each unit sold is $120, and the variable cost per unit is $60. How many units must the firm sell to reach the cash break-even point?

A)Less than 7,333 units
B)7,333 units
C)More than 7,333 units
D)Not enough information has been provided to determine the cash break-even point.

Question 77

A high DOL means

A)there are high labor costs.
B)there is high debt.
C)there is a large amount of equity.
D)there are high fixed costs.

Question 78

If a firm has the lowest possible degree of operating leverage and the lowest possible degree of financial leverage, then

A)DOL equals 1, and DFL equals 0.
B)DOL equals 0, and DFL equals 1.
C)DOL equals 1, and DFL equals 1.
D)None of the options

Question 79

If EBIT equals $200,000 and interest equals $40,000, what is the degree of financial leverage?

A)5.33x
B)1.25x
C).8125x
D)4.33x

Question 80

The degree of financial leverage is concerned with the relationship between

A)changes in volume and changes in EPS.
B)changes in volume and changes in EBIT.
C)changes in EBIT and changes in EPS.
D)changes in EBIT and changes in operating income.