Question 1

Since the sales price per unit generally decreases with volume and the cost per unit generally increases with volume,the true breakeven point may be different from those obtained using linear revenue and cost functions as assumed in the breakeven analysis.

Accepted Answer

A) True 
 B)False

Question 2

Total leverage can be defined as the potential use of fixed costs,both operating and financial,to magnify the effect of changes in sales on a firm's earnings per share.

Accepted Answer

A) True 
 B)False

Question 3

Operating leverage is defined as the use of fixed operating costs to magnify the effects of changes in sales on a firm's earnings before interest and taxes.

Accepted Answer

A) True 
 B)False

Question 4

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.

Question 5

A firm's capital structure is the mix of the current liabilities,long-term debt,and equity maintained by the firm.

Accepted Answer

A) True 
 B)False

Question 6

Generally,increases in leverage result in increased return and risk.

Accepted Answer

A) True 
 B)False

Question 7

The basic shortcoming of EBIT-EPS analysis is that this model focuses on the maximization of earnings rather than on the maximization of owner wealth as reflected in a firm's stock price.

Accepted Answer

A) True 
 B)False

Question 8

In theory,a firm's optimal capital structure is that which minimized the firm's overall cost of capital resulting in a maximization of the market value of a firm.

Accepted Answer

A) True 
 B)False

Question 9

In general,the greater a firm's operating leverage,the higher its business risk.

Accepted Answer

A) True 
 B)False

Question 10

Which of the following is a basic source of capital for a firm?

Accepted Answer

A)  short-term debt 
B)  discounts from suppliers 
C)  current liabilities 
D)  common stock

Question 11

Effective capital structure decisions can lower the cost of capital,resulting in higher NPVs and more acceptable projects,thereby increasing the value of a firm.

Accepted Answer

A) True 
 B)False

Question 12

The pecking order explanation of capital structure states that a hierarchy of financing exists for firms,in which retained earnings are employed first,followed by debt financing and finally by external equity financing.

Accepted Answer

A) True 
 B)False

Question 13

Due to the difficulty of allocating costs to products in a multiproduct firm,the breakeven model may fail to determine breakeven points for each product line.

Accepted Answer

A) True 
 B)False

Question 14

Table 12.1 
-What is the EPS under Financing Plan 1,if the firm projects EBIT of $200,000 and has a tax rate of 40 percent? (See Table 12.1)

Accepted Answer

The answer of Table 12.1 
-What is the EPS under...

Question 15

A corporation has $5,000,000 of 10 percent bonds and $3,000,000 of 12 percent preferred stock outstanding.The firm's financial breakeven (assuming a 40 percent tax rate)is ________.

Accepted Answer

A)  $860,000 
B)  $716,000 
C)  $1,100,000 
D)  $1,400,000

Question 16

A firm has fixed operating costs of $253,750,a sales price per unit of $100,and a variable cost per unit of $65.The firm's operating breakeven point in dollars is ________.

Accepted Answer

A)  $725,000 
B)  $700,000 
C)  $906,250 
D)  $390,385

Question 17

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 18

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 19

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

Question 20

For sales levels below the operating breakeven point,sales revenue exceeds total operating costs,and earnings before interest and taxes is greater than zero.

Accepted Answer

A) True 
 B)False

Exam 12: Leverage and Capital Structure

Since the sales price per unit generally decreases with volume and the cost per unit generally increases with volume,the true breakeven point may be different from those obtained using linear revenue and cost functions as assumed in the breakeven analysis.

Total leverage can be defined as the potential use of fixed costs,both operating and financial,to magnify the effect of changes in sales on a firm's earnings per share.

Operating leverage is defined as the use of fixed operating costs to magnify the effects of changes in sales on a firm's earnings before interest and taxes.

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

A firm's capital structure is the mix of the current liabilities,long-term debt,and equity maintained by the firm.

Generally,increases in leverage result in increased return and risk.

The basic shortcoming of EBIT-EPS analysis is that this model focuses on the maximization of earnings rather than on the maximization of owner wealth as reflected in a firm's stock price.

In theory,a firm's optimal capital structure is that which minimized the firm's overall cost of capital resulting in a maximization of the market value of a firm.

In general,the greater a firm's operating leverage,the higher its business risk.

Which of the following is a basic source of capital for a firm?

Effective capital structure decisions can lower the cost of capital,resulting in higher NPVs and more acceptable projects,thereby increasing the value of a firm.

The pecking order explanation of capital structure states that a hierarchy of financing exists for firms,in which retained earnings are employed first,followed by debt financing and finally by external equity financing.

Due to the difficulty of allocating costs to products in a multiproduct firm,the breakeven model may fail to determine breakeven points for each product line.

Table 12.1 -What is the EPS under Financing Plan 1,if the firm projects EBIT of $200,000 and has a tax rate of 40 percent? (See Table 12.1)

A corporation has $5,000,000 of 10 percent bonds and $3,000,000 of 12 percent preferred stock outstanding.The firm's financial breakeven (assuming a 40 percent tax rate) is ________.

A firm has fixed operating costs of $253,750,a sales price per unit of $100,and a variable cost per unit of $65.The firm's operating breakeven point in dollars is ________.

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.

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.

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

For sales levels below the operating breakeven point,sales revenue exceeds total operating costs,and earnings before interest and taxes is greater than zero.