Question 1

When fixed capital costs are incurred by the firm, a change in ____ is magnified into a larger change in earnings per share.

Accepted Answer

A)   earnings before interest and taxes
B)   overhead expenses
C)   interest charges
D)   preferred dividends A

Question 2

A firm is considering the purchase of assets that will increase its fixed operating costs. The firm should decrease the proportion of ____ it employs in its capital structure if it wants to maintain its existing degree of combined leverage.

Accepted Answer

A)   debt
B)   warrants
C)   common stock
D)   common stock and warrants A

Question 3

TCA Cable has fixed operating costs of $2.6 million, and its variable cost ratio is 0.30. TCA has $4.0 million in bonds outstanding with a coupon interest rate of 12%. TCA has 1.0 million common shares and 1,000,000 shares of $1.75 preferred stock outstanding. Total revenues for TCA Cable are $14.2 million. If TCA has a marginal tax rate of 40%, what is its degree of combined leverage?

Accepted Answer

A)   2.1
B)   1.0
C)   1.9
D)   2.5 D

Question 4

Sulzar's capital structure consists only of common stock (20 million shares), but the firm is planning a major expansion, which will require $100 million of new capital. Sulzar has a choice of obtaining the needed capital through the sale of 5 million shares of common stock at $20 per share or the sale of $100 million of first mortgage bonds that would have a coupon rate of 9%. Assuming Sulzar has a marginal tax rate of 40%, calculate the EBIT-EPS indifference point.

Accepted Answer

A)   $45 million
B)   $36 million
C)   $5 million
D)   $9 million

Question 5

Two companies, Jefferson and Jackson, are virtually identical in all aspects of their operations except that the two companies differ in their capital structures, as shown below. Jefferson
$$\begin{array} { l r r } 
& \text { Jefferson } & \text { Jackson } \
\text { Debt } ( 10 \% ) & \$ 200 \text { million } & \$ 100 \text { million } \
\text { Common equity } & \$ 300 \text { million } & \$ 400 \text { million } \
\text { No. shares outstanding } & 15 \text { million } & 20 \text { million }
\end{array}$$
?
Both companies have $500 million in total assets and both have a 40% marginal tax rate. What is the EPS for Jefferson at an EBIT level of $50 million?

Accepted Answer

A)   -$1.20
B)   $1.20
C)   $2.20
D)   $3.33

Question 6

Onyx expects to have an EBIT of $240,000 with a standard deviation of $110,000. The distribution of operating income is approximately normal. If Onyx has interest expenses of $50,000, what is the probability that it will have an operating income that is below $0? (Problem requires a normal distribution table.)

Accepted Answer

A)   4.27%
B)   1.46%
C)   0.02%
D)   2.4%

Question 7

Sitco has a total of $12 million in cash and marketable securities. Free cash flows during the coming year are expected to be $47 million with a standard deviation of $31 million. Assume that Sitco's free cash flows are approximately normally distributed. What is the probability that Sitco will run out of cash during the coming year?

Accepted Answer

A)   29.98%
B)   34.83%
C)   97.13%
D)   2.87%

Question 8

The Lincoln Mint produces various types of one ounce silver commemorative medals for sale to collectors. The cost of producing and selling a given medal is as follows: $\begin{array}{lr}\text { Fixed costs: }\
\text { Design and preparation of dies } & \$ 8,000 \
\text { Promotion and selling expenses } & 25,000 \
\text { Administrative overhead } & 7,000 \
\quad \text { Total } & \$ 40,000 \
\text { Variable costs: }\
\text { Silver blanks } & \$ 6.00 \
\text { Striking medals } & 0.50 \
\text { Mailing expenses } & 3.50\
\text { Total }&\$10.00\\
\text { Projected selling price: }&\$14.00
\end{array}$
What is the degree of operating leverage at an output level of 15,000 units?

Accepted Answer

A)   0.0
B)   1.0
C)   3.0
D)   cannot be determined from the information provided

Question 9

Rent, insurance, and the salaries of top management are examples of ____.

Accepted Answer

A)   fixed costs
B)   capital costs
C)   variable costs
D)   fluctuating costs

Question 10

Kenzel has an EPS of $4.20, and sales are $9 million. Assuming the firm has a degree of operating leverage of 4.0 and a degree of financial leverage of 5.2, forecast EPS if the firm expects a 4% sales decline.

Accepted Answer

A)   $0.71
B)   $3.49
C)   $4.03
D)   $3.33

Question 11

Leigh Fibers expects its operating income over the coming year to equal $2.5 million with a standard deviation of $800,000. Leigh must pay interest charges of $1.2 million next year and preferred dividends of $300,000. Leigh's marginal tax rate is 35%. What is the probability that Leigh will have negative EPS next year if its operating income is expected to be normally distributed? (Problem requires a normal distribution table.)

Accepted Answer

A)   14.7%
B)   5.2%
C)   10.6%
D)   15.7%

Question 12

Magnificent Manes Hair Salons is forecasting a 17% increase in sales. What would be its degree of operating leverage if it anticipates that its EBIT will go from $150,000 to $175,000 during the same time frame?

Accepted Answer

A)   1.76
B)   2.5
C)   .98
D)   1.11

Question 13

Weis Products has fixed operating costs of $20 million and a variable cost ratio of 0.55. Weis has 4 million common shares outstanding and a marginal tax rate of 45%. What is Weis's degree of operating leverage at an expected sales level of $150 million?

Accepted Answer

A)   1.00
B)   1.74
C)   1.42
D)   1.32

Question 14

ASG expects next year's operating income (EBIT) to equal $22 million, with a standard deviation of $16 million. The coefficient of variation of operating income is equal to 0.73. Interest expenses will be $9 million next year and debt retirement will require a principal payment of $2.5 million. ASG's marginal tax rate is 40%. If EBIT is normally distributed, what is the probability that ASG will have a negative EPS next year? (Problem requires a normal distribution table.)

Accepted Answer

A)   20.9%
B)   25.5%
C)   23.3%
D)   25.8%

Question 15

In evaluating a firm's degree of financial leverage, financial risk is ____ with an increase in DFL.

Accepted Answer

A)   increased
B)   decreased
C)   not impacted
D)   reflective of excess inventory

Question 16

The degree of combined leverage is defined as the percentage change in earnings per share resulting from a given percentage change in ____.

Accepted Answer

A)   operating costs
B)   interest charges
C)   common stock dividends
D)   sales (or output)

Question 17

In using Nestlé Corporation as a model, when a subsidiary is first formed, about one-half of the financing needed to acquire fixed assets comes from ____.

Accepted Answer

A)   debt
B)   federal funds
C)   tax breaks
D)   equity from the parent company

Question 18

Ipsy Dipsy Preschools Inc. has a capital structure that consists of 60% common equity (2.0 million shares), 30% long-term debt ($10 million with 12% coupon), and 10% preferred stock ($50 par value with $4.75 dividend). The company is planning a major plant expansion and is undecided between the following two financing plans: ​
1) Equity financing: Sale of 400,000 shares of common at $10 each
2) Debt financing: Sale of $4 million of 12.5 percent long-term bonds
​
Calculate the EBIT-EPS indifference point, assuming the marginal tax rate is 40%.

Accepted Answer

A)   $4.253 million
B)   $3.051 million
C)   $3.654 million
D)   $4.728 million

Question 19

In considering EBIT-EPS analysis, which of the following statements is (are) correct?

Accepted Answer

A)   If the expected earnings are above the indifference point, the debt option is preferred.
B)   If the expected earnings are below the indifference point, the equity option is preferred.
C)   Both statements are correct.
D)   Neither statement is correct.

Question 20

There are three categories of costs: fixed costs, variable costs and semi-variable costs. Which of the following is a semi-variable cost?

Accepted Answer

A)   depreciation
B)   labor costs
C)   raw materials
D)   management salaries

Exam 17: Capital Structure Management in Practice