Deck 12: Determining the Financing Mix

Question 1

Break-even analysis ignores fixed costs because fixed costs do not change.

Answer 1

False

Question 2

A high degree of variability in a firm's earnings before interest and taxes refers to

A) business risk.
B) financial risk.
C) financial leverage.
D) operating leverage.

Answer 2

business risk.

Question 3

Variation in a company's income stream results from its choice of business line,its choice of an operating cost structure,and its choice of a capital structure.

Answer 3

False

Question 4

As the volume of production increases the variable cost-per unit of the product decreases.

Question 5

A decrease in the level of production results in decreased fixed cost per unit.

Question 6

Companies that sell basic necessities face the highest levels of business risk because consumers will price shop aggressively for items they purchase on a regular basis.

Question 7

The four basic determinants of business risk include all of the following except:

A) the stability of the domestic economy.
B) the level of fixed cost used in the company's production process.
C) sensitivity to the business cycle.
D) competitive pressures in the firm's industry.

Question 8

The break-even quantity of output is that quantity of output,in units,that results in an EBIT equal to zero.

Question 9

Private equity funds tend to focus their investments in situations where promised returns are very high and the need for funds is brief.

Question 10

Sales of consumer durable goods,such as appliances,are more sensitive to swings in the business cycle,and therefore companies in these industries face a higher level of operating risk.

Question 11

A key tool for evaluating business risk is break-even analysis.

Question 12

Corporations utilize external financing either because they do not have sufficient earnings to reinvest or they want to rebalance their capital structures.

Question 13

As production levels increase,fixed costs stay the same in total,but decrease on a per unit basis.

Question 14

The three major components responsible for variation in a company's income stream are business risk,operating risk,and financial risk.

Question 15

Break-even analysis is a short-term concept because,in the long run,all costs are variable.

Question 16

Business risk refers to the relative dispersion of a firm's earnings before interest and taxes.

Question 17

Business risk refers to

A) the risk associated with financing a firm with debt.
B) the variability of a firm's expected earnings before interest and taxes.
C) the uncertainty associated with a firm's CAPM.
D) the variability of a firm's stock price.

Question 18

Fixed costs are called indirect costs while variable costs are called direct costs.

Question 19

If sales double,the break-even model assumes that total variable costs will double.

Question 20

Business risk refers to the relative dispersion (variability)of a company's net income.

Question 21

Depreciation is considered a fixed cost.

Question 22

A plant may remain operating when sales are depressed

A) if the selling price per unit exceeds the variable cost per unit.
B) to help the local economy.
C) in an effort to cover at least some of the variable cost.
D) unless variable costs are zero when production is zero.

Question 23

Fixed operating costs include charges incurred from the firm's use of debt financing.

Question 24

The break-even model enables the manager of the firm to

A) calculate the minimum price of common stock for certain situations.
B) set appropriate equilibrium thresholds.
C) determine the quantity of output that must be sold to cover all operating costs.
D) determine the optimal amount of debt financing to use.

Question 25

The break-even point is equal to

A) fixed costs divided by (sales price per unit - variable cost per unit).
B) fixed costs divided by unit variable costs.
C) fixed costs divided by selling price per unit.
D) (sales price per unit - variable cost per unit) times the fixed costs.

Question 26

Kocher Steel typically achieves one of three production levels in any given year: 8 million pounds of steel,10 million pounds of steel,or 16 million pounds of steel.In tracking some of its costs,Kocher Steel's controller discovered one cost that was $10 per pound no matter what the production level for the year.This is an example of a

A) variable cost.
B) fixed cost.
C) semivariable cost.
D) semifixed cost.

Question 27

Break-even analysis is used to study the effect on EBIT of changes in all of the following except:

A) corporate taxes.
B) prices.
C) cost structure.
D) volume.

Question 28

In break-even analysis,semivariable costs are segregated into their fixed and variable components over the relevant range of output.

Question 29

Potential applications of the break-even model include

A) replacement for time-adjusted capital budgeting techniques.
B) pricing policy.
C) optimizing the cash-marketable securities position of a firm.
D) all of the above.

Question 30

Which of the following is a fixed cost?

A) insurance
B) direct material
C) direct labor
D) freight costs on products

Question 31

Moline Manufacturing Corporation reported the following items: Sales = $6,000,000; Variable Costs of Production = $1,500,000; Variable Selling and Administrative Expenses = $550,000; Fixed Costs = $1,350,000; EBIT = $2,600,000; and the Marginal Tax Rate =35%.Moline's break-even point in sales dollars is

A) $2,050,633.
B) $2,197,500.
C) $2,438,750.
D) $2,785,000.

Question 32

Fixed costs per unit vary inversely with production output.

Question 33

Amish Enterprises makes wooden play sets.The company pays annual rent of $400,000 per year and pays administrative salaries totaling $150,000 per year.Each play set requires $400 of wood,ten hours of labor at $70 per hour,and variable overhead costs of $100.Fixed advertising expenses equal $100,000 per year.Each play set sells for $3,200.What is Amish Enterprises' break-even output level?

A) 340 play sets
B) 325 play sets
C) 297 play sets
D) 258 play sets

Question 34

Over the relevant range of output,fixed costs remain unchanged.

Question 35

The break-even model assumes that selling price per unit and variable cost per unit of output are constant over the relevant range of output.

Question 36

As production levels increase,

A) variable costs per unit decrease.
B) fixed costs per unit increase.
C) fixed costs per unit stay the same and variable costs per unit increase.
D) fixed costs per unit decrease and variable costs per unit stay the same.

Question 37

Variable costs include all of the following except:

A) property taxes.
B) direct labor.
C) sales commissions.
D) annual rent.

Question 38

Jones Blanket Company sells blankets for $25 each.The variable cost of each blanket is $10.If fixed cost is $4,500,000 then the break-even point is 300,000 units.

Question 39

Kocher Steel typically achieves one of three production levels in any given year: 8 million pounds of steel,10 million pounds of steel,or 16 million pounds of steel.In tracking some of its costs,Kocher Steel's controller discovered one cost that was $10 per pound at a production level of 8 million pounds,$8 per pound at a production level of 10 million pounds,and $5 per pound at a production level of 16 million pounds.This is an example of a

A) variable cost.
B) fixed cost.
C) semivariable cost.
D) semifixed cost.

Question 40

If fixed costs are $150,000,price per unit is $10,and variable cost per unit is $4,the break-even point is 15,000 units.

Question 41

The Western Boot Company will produce 94,000 pairs of boots next year.Variable costs are 35 percent of sales,while fixed costs total $223,000.At what price must each pair of boots be sold for Western to obtain an EBIT of $1,391,500?

Question 42

The break-even point in sales dollars is convenient if

A) the firm sells a large amount of one product.
B) the firm deals with more than one product.
C) the price per unit is very low.
D) depreciation expense is high.

Question 43

JKE,Inc.has a break even sales level of $10,000,000 and has fixed costs of $4,000,000 per year.The selling price per unit is $200.What is the variable cost per unit?

Question 44

All of the following will make the break-even point increase,other things equal,except:

A) fixed costs increase.
B) the sales price per unit is decreased due to competition.
C) variable costs increase due to higher direct labor cost.
D) the number of units sold for the year decreased.

Question 45

The Knight Corporation projects that next year its fixed costs will total $240,000.Its only product sells for $34 per unit,of which $18 is a variable cost.The management of Knight is considering the purchase of a new machine that will lower the variable cost per unit to $14.The new machine,however,will add to fixed costs through an increase in depreciation expense.How large can the addition to fixed costs be in order to keep the firm's break-even point in units produced and sold unchanged?

Question 46

Wheely Bike Manufacturers expects to produce and sell 9,000 made-to-order bicycles this year.Variable costs are 40 percent of sales while fixed costs total $600,000.At what price must each bicycle be sold for Wheely to earn EBIT of $450,000?

Question 47

Joe's Furniture Co.produces inexpensive leather chairs.The average selling price for one of the chairs is $400.The variable cost per chair is $250.Benny's has average fixed costs per year of $450,000.
a.What is the break-even point in units?
b.What is the break-even point in dollar sales?
c.What would be the operating profit or loss associated with the production and sale of (1)3,000 chairs,(2)4,000 chairs?

Question 48

Benkart's Tire Store has fixed costs of $220,000.Tires sell for $95 each and have a unit variable cost of $45.What is Benkart's break-even point in units?

A) 4,000
B) 4,400
C) 5,200
D) 5,500

Question 49

Based on the data contained in Table A,what is the break-even point in sales dollars?
TABLE A

A) $2,340,000
B) $1,850,000
C) $1,775,500
D) $700,000

Question 50

Sweet Tooth Bakery bakes and sells pies.Sweet Tooth has annual fixed costs of $880,000 and a variable cost per pie of $7.50.Each pie sells for $15.50 each.The firm expects to sell 500,000 pies annually.What is the break-even point in sales dollars?

A) $3,100,000
B) $2,875,000
C) $1,705,000
D) $1,625,000

Question 51

DXZ,Inc.currently produces one product which sells for $250 per unit.The company's fixed costs are $75,000 per year; variable costs are $205 per unit.A salesman has offered to sell the company a new piece of equipment which will increase fixed costs to $100,000.The salesman claims that the company's break-even point will not be altered if the company purchases this equipment.What will be the company's new variable cost per unit?

Question 52

Stan's Cans,Inc.expects to earn $150,000 next year after taxes on sales of $2,200,000.Stan's manufactures only one size of garbage can.Stan sells his cans for $8 apiece and they have a variable cost of $2.40 apiece.Stan's tax rate is currently 34%.
a.What are the firm's expected fixed costs for next year?
b.What is the break-even point in units?

Question 53

Welker Products sells small kitchen gadgets for $15 each.The gadgets have a variable cost of $4 per unit,and Welker Products' fixed operating costs are $220,000 per year.Welker Products' capital structure includes 55% debt and 45% equity.Annual interest expense is $25,000,and the corporate tax rate is 35%.
a.Calculate the break-even point in units.
b.If Welker Products sells 25,000 units,calculate the firm's EBIT and net income.
c.If sales increase ten percent from 25,000 units to 30,000 units,estimate the firm's expected EBIT and net income.
d.Does Kelly Products use operating leverage and/or financial leverage?
Explain.

Question 54

Which of the following would be considered a fixed cost in a manufacturing setting?

A) Depreciation
B) Direct labor
C) Sales commissions
D) Direct materials

Question 55

Based on the data contained in Table A,what is the break-even point in units produced and sold?
TABLE A

A) 130,000
B) 140,000
C) 150,000
D) 180,000

Question 56

Techno Robots produces a functioning toy robot.At a production and sales level of 10,000 robots,the firm has the following information:
Selling price per unit = $15
Variable costs per unit = $8
EBIT = $17,500
a.What is the break-even point in units for the firm?

Question 57

Sweet Tooth Bakery bakes and sells pies.Sweet Tooth has annual fixed costs of $880,000 and a variable cost per pie of $7.50.Each pie sells for $15.50 each.The firm expects to sell 500,000 pies annually.What is the break-even point in pies?

A) 190,440
B) 280,000
C) 200,000
D) 110,000

Question 58

Which of the following would be considered a variable cost in a manufacturing setting?

A) Rent
B) Administrative salaries
C) Insurance
D) Direct labor

Question 59

Operating leverage is easier to control and manage than financial leverage because operating leverage deals with the internal workings of the company while financing deals with outside parties.

Question 60

ABC Corp.has estimated the following income statement for its next fiscal year.
a.What is the break-even point in sales dollars for the firm?
b.If the average unit cost is $20,what is the break even point in units?

Question 61

Financial leverage is typically more under the control of management than is operating leverage because the nature of the product often dictates the type of production process needed.

Question 62

Break-even analysis assumes that a multiproduct firm maintains a constant production and sales mix.

Question 63

Financial risk applies to both the additional variability in earnings available to common shareholders and the additional chance of insolvency caused by the use of financial leverage.

Question 64

Operating leverage is the responsiveness of a firm's EBIT to changes in sales revenues.

Question 65

If a firm's production process requires high operating leverage (use of fixed costs),then the firm should finance its assets with debt,so that the cost of capital will be reduced and financing costs will remain fixed.

Question 66

The presence of debt and/or preferred stock in a firm's financial structure means the firm is using financial leverage.

Question 67

Operating leverage contributes ultimately to the variability of a firm's earnings per share.

Question 68

The more fixed-charge securities (such as bonds and preferred stock)the firm employs in its financial structure,the greater its financial leverage.

Question 69

Which of the following transactions will lower a company's financial leverage?

A) A mortgage loan is obtained and the proceeds are used to pay off existing short-term debt.
B) Preferred stock is sold and the proceeds are used to pay off existing short-term debt.
C) Common stock is sold and the proceeds are used to pay off existing short-term debt.
D) Short-term debt is obtained to get the company through a period of negative net income and cash flow.

Question 70

Ames Drilling Corp.reported that its sales and EBIT increased by 10%,but its EPS increased by 30%.The much larger change in earnings per share could be the result of

A) high operating leverage.
B) high financial leverage.
C) a high percentage of credit sale collections from prior years.
D) high fixed costs of production.

Question 71

All of the following are likely to result in the use of less debt in a company's capital structure except:

A) desire to maintain financial flexibility.
B) desire to maintain a high credit rating.
C) insufficient internal funds.
D) a decrease in a company's marginal tax rate.

Question 72

A company that sells preferred stock and uses the money to pay off a loan is decreasing its amount of financial leverage.

Question 73

An increase in financial leverage will increase the absolute value of EPS,everything else equal.

Question 74

A company that sells common stock and uses the money to pay off a loan is increasing its use of financial leverage.

Question 75

Operating leverage is measured as the responsiveness of the firm's earnings before interest and taxes relative to fluctuations in sales.

Question 76

If a company sells bonds and uses the proceeds to buy back common stock,the company's financial leverage with increase.

Question 77

Operating leverage means financing a portion of a firm's earnings per share with debt.

Question 78

Because fixed costs do not vary with a firm's revenues,firm's with high levels of fixed cost enjoy lower levels of operating risk because their costs are more certain,making budgeting easier.

Question 79

Because financial markets can be extremely volatile,with bond and stock prices changing significantly from day to day,a firm's management has much greater control over the firm's operating leverage than over its financial leverage.

Question 80

A CEO concerned about variability of earnings per share may try to offset high operating leverage with a capital structure that is mostly debt in order to take advantage of the interest tax shield.