Question 1

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)  D

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

The Albany Corporation has a present capital structure consisting of common stock ($200 million, 10 million shares) and debt ($150 million, 8%). The company is planning a major expansion and is undecided between two financing plans. Plan A: Equity financing. Under this plan, an additional 2.5 million shares of common stock will be sold at $ 15  each.
Plan B: Debt financing. Under this plan, $ 37.5 million of 10% long-term debt will be sold.
What happens to the EBIT indifference point if the interest rate on the new debt decreases and the common stock price remains constant?

Accepted Answer

A)   the indifference point increases
B)   the indifference point decreases
C)   the indifference point does not change
D)   cannot be determined from the information provided B

Question 4

Given the following financial data for Boston Technology, compute the firm's degree of combined leverage. Assume a marginal tax rate of 40%.

Accepted Answer

A)   0.29
B)   -0.38
C)   -0.15
D)   0.38

Question 5

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. Assume 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 6

The Albany Corporation has a present capital structure consisting of common stock ($200 million, 10 million shares) and debt ($150 million, 8%). The company is planning a major expansion and is undecided between two financing plans. Plan A: Equity financing. Under this plan, an additional 2.5 million shares of common stock will be sold at $ 15 each.
Plan B: Debt financing. Under this plan, $37.5 million of 10% long-term debt will be sold.
What is the EBIT-EPS indifference point? Assume a 40 percent marginal tax rate.

Accepted Answer

A)   $33.9 million
B)   $30.75 million
C)   $37.0 million
D)   $12.9 million

Question 7

Given the following financial data for Cosmos, compute the firm's degree of financial leverage.

Accepted Answer

A)   23.81
B)   4.24
C)   0.42
D)   2.18

Question 8

Twin City Printing is considering two financial alternatives for financing a major expansion program. Under either alternative EBIT is expected to be $15.6 million. Currently the firm's capital structure consists of 4 million shares of common stock and $35 million in 11% long-term bonds. Under the debt financing alternative $10 million in 12% long-term bonds will be sold and under the equity financing alternative the firm would sell 500,000 shares of common stock. The P/E under the debt alternative would be 15 and the P/E under the equity alternative would be 16. The firm's marginal tax rate is 40%. Which alternative would produce the higher stock price?

Accepted Answer

A)   debt--stock price of $23.70
B)   debt--stock price of $32.29
C)   equity--stock price of $25.12
D)   equity--stock price of $33.28

Question 9

Cash insolvency analysis evaluates the adequacy of a firm's cash position in a

Accepted Answer

A)   bankruptcy proceeding
B)   non-normal environment
C)   highly competitive environment
D)   recessionary environment

Question 10

What is the degree of operating leverage for Flippin' Out Company, a maker of scuba flippers, f the firm sells its finished product for $50 per unit with variable costs per unit of $15? The company has fixed operating costs of $2,000,000 and sells 200,000 units (the answer is rounded).

Accepted Answer

A)   2.0
B)   3.7
C)   6.5
D)   1.4

Question 11

The percentage change in a firm's EBIT that results in a 1% change in sales or output is known as the

Accepted Answer

A)   degree of combined leverage
B)   degree of financial leverage
C)   degree of operating leverage
D)   degree of business risk

Question 12

Last year Alpine Growers experienced a 34% increase in earnings per share on 11% increase in sales. If management knows that Alpine's DOL is 1.5, what is its DFL?

Accepted Answer

A)   3.09
B)   2.06
C)   3.55
D)   1.67

Question 13

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

Question 14

Suppose that ITC's degree of combined leverage (DCL) is 3.00 at a sales volume of $9 million. Determine ITC's percentage change in earnings per share (EPS) if forecasted sales increase by 20 percent to $10,800,000.

Accepted Answer

A)   60%
B)   50%
C)   32%
D)   30%

Question 15

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?

Accepted Answer

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

Question 16

Kenzel has an EPS of $4.20 and sales are $9 million. If 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 17

Dagger Company has a current capital structure consisting of $60 million in long-term debt with an interest rate of 9% and $60 million in common equity (12 million shares). The firm is considering an expansion plan costing $23 million. The expansion plan can be financed with additional long-term debt at a 12% interest rate or the sale of new common stock at $8 per share. The firm's marginal tax rate is 40%. Determine the indifference level of EBIT for the two financing plans.

Accepted Answer

A)   -$30.24 million
B)   $18.36 million
C)   $30.24 million
D)   $19.68 million

Question 18

The use of increasing amounts of combined leverage ____ the risk of financial distress.

Accepted Answer

A)   decreases
B)   increases
C)   has no effect on
D)   creates diversity in

Question 19

A firm that employs relatively large amounts of labor- saving equipment in its operations will have a relatively ____ degree of operating leverage.

Accepted Answer

A)   low
B)   constant
C)   insignificant
D)   high

Question 20

Crown Data(CD) has a current capital structure that consists of $120 million in common equity (15 million shares) and $80 million in long-term debt with an average interest rate of 11 percent. CD is considering an expansion project that will cost $22 million. The project will be financed either by issuing long-term debt at a cost of 12.5 percent, or the sale of new common stock at $35 per share. The firm's marginal tax rate is 40%. What is the EBIT indifference point between the two financing options.

Accepted Answer

A)   $71.5 million
B)   $77.2 million
C)   $68.3 million
D)   $ 1.0 million

Exam 14: Capital Structure Management in Practice