Question 1

The ________ approach to capital structure proposes that an optimal capital structure be selected which ________.

Accepted Answer

A)  M and M; maximizes the weighted average cost of capital 
B)  traditional; minimizes the cost of debt 
C)  EBIT-EPS; maximizes the EPS 
D)  residual theory; minimizes dividends

Question 2

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

Accepted Answer

A) True 
 B)False

Question 3

Tony's Beach T-Shirts has fixed annual operating costs of $75,000. Tony retails his T-shirts for $14.99 each and the variable cost per T-shirt is $4.99. Based on this information, the breakeven sales level in units is

Accepted Answer

A)  7,500. 
B)  15,030. 
C)  5,003. 
D)  none of the above.

Question 4

After satisfying obligations to creditors, the government, and preferred stockholders, any remaining earnings will most likely be allocated to any of the following EXCEPT

Accepted Answer

A)  common shareholders as cash dividends. 
B)  common shareholders as stock dividends. 
C)  retained by the firm for future investment. 
D)  a combination of retained earnings and cash dividends.

Question 5

The cash breakeven point is used when certain noncash charges, such as depreciation, constitute an important portion of the firm's fixed operating costs.

Accepted Answer

A) True 
 B)False

Question 6

The EBIT-EPS approach to capital structure involves selecting the capital structure that maximizes earnings before interest and taxes (EBIT) over the expected range of earnings per share (EPS).

Accepted Answer

A) True 
 B)False

Question 7

A firm has fixed operating costs of $525,000, of which $125,000 is depreciation expense. The firm's sales price per unit is $35 and its variable cost per unit is $22.50. The firm's cash operating breakeven point in units is

Accepted Answer

A)  23,330. 
B)  32,000. 
C)  42,000. 
D)  52,000.

Question 8

Through the effects of financial leverage, when EBIT increases, earnings per share will

Accepted Answer

A)  increase. 
B)  decrease. 
C)  remain unchanged. 
D)  change in an undetermined direction.

Question 9

The asymmetric information explanation of capital structure suggests that firms will issue new equity only when the managers believe the firm's stock is overvalued; as a result, issuing new equity is considered a negative signal that will result in a decline in share price.

Accepted Answer

A) True 
 B)False

Question 10

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 11

When considering fixed operating cost increases, the financial manager must weigh the increased financial risk associated with greater operating leverage against the expected increase in returns.

Accepted Answer

A) True 
 B)False

Question 12

Which one of the following is considered a limitation of breakeven analysis?

Accepted Answer

A)  It assumes that the firm faces linear, or nonvarying, sales revenue and total operating cost functions. 
B)  It is difficult to break semivariable costs into fixed and variable components. 
C)  It has a short-term time horizon. 
D)  All of the above.

Question 13

________ leverage is concerned with the relationship between sales revenue and earnings per share.

Accepted Answer

A)  Financial 
B)  Operating 
C)  Variable 
D)  Total

Question 14

Yongman Electronics has decided to invest $10,000,000 in a new headquarters and needs to determine the best way to finance the construction. The firm currently has $50,000,000 of 10 percent bonds and 4,000,000 common shares outstanding. The firm can obtain the $10,000,000 of financing through a 10 percent bond issue or the sale of 1,000,000 shares of common stock. The firm has a 40 percent tax rate.
(a) What is the degree of financial leverage for each plan at $25,000,000 of EBIT?
(b) What is the financial breakeven point for each plan?

Accepted Answer

The answer of Yongman Electronics has decided to invest $10,000,000...

Question 15

The degree of operating leverage depends on the base level of sales used as a point of reference. The closer the base sales level used is to the operating breakeven point, the greater the operating leverage.

Accepted Answer

A) True 
 B)False

Question 16

A firm has interest expense of $145,000, preferred dividends of $25,000, and a tax rate of 40 percent. The firm's financial breakeven point is

Accepted Answer

A)  $ 25,000. 
B)  $170,000. 
C)  $186,667. 
D)  $145,000.

Question 17

Which of the following is NOT a variable cost?

Accepted Answer

A)  Materials used. 
B)  Rent. 
C)  Delivery costs. 
D)  Direct labor.

Question 18

________ is the potential use of fixed operating costs to magnify the effects of changes in sales on earnings before interest and taxes.

Accepted Answer

A)  Financial leverage 
B)  Operating leverage 
C)  Total leverage 
D)  Ratio analysis

Question 19

Business risk is the risk to the firm of being unable to cover operating costs.

Accepted Answer

A) True 
 B)False

Question 20

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.

Exam 12: Leverage and Capital Structure

The approach to capital structure proposes that an optimal capital structure be selected which .

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

Tony's Beach T-Shirts has fixed annual operating costs of $75,000. Tony retails his T-shirts for $14.99 each and the variable cost per T-shirt is $4.99. Based on this information, the breakeven sales level in units is

After satisfying obligations to creditors, the government, and preferred stockholders, any remaining earnings will most likely be allocated to any of the following EXCEPT

The cash breakeven point is used when certain noncash charges, such as depreciation, constitute an important portion of the firm's fixed operating costs.

The EBIT-EPS approach to capital structure involves selecting the capital structure that maximizes earnings before interest and taxes (EBIT) over the expected range of earnings per share (EPS).

A firm has fixed operating costs of $525,000, of which $125,000 is depreciation expense. The firm's sales price per unit is $35 and its variable cost per unit is $22.50. The firm's cash operating breakeven point in units is

Through the effects of financial leverage, when EBIT increases, earnings per share will

The asymmetric information explanation of capital structure suggests that firms will issue new equity only when the managers believe the firm's stock is overvalued; as a result, issuing new equity is considered a negative signal that will result in a decline in share price.

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.

When considering fixed operating cost increases, the financial manager must weigh the increased financial risk associated with greater operating leverage against the expected increase in returns.

Which one of the following is considered a limitation of breakeven analysis?

________ leverage is concerned with the relationship between sales revenue and earnings per share.

The degree of operating leverage depends on the base level of sales used as a point of reference. The closer the base sales level used is to the operating breakeven point, the greater the operating leverage.

A firm has interest expense of $145,000, preferred dividends of $25,000, and a tax rate of 40 percent. The firm's financial breakeven point is

Which of the following is NOT a variable cost?

________ is the potential use of fixed operating costs to magnify the effects of changes in sales on earnings before interest and taxes.

Business risk is the risk to the firm of being unable to cover operating costs.

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