Question 1

Coats Corp.generates $10,000,000 in sales.Its variable costs equal 85.00% of sales and its fixed costs are $500,000.Therefore,the company's operating income (EBIT)equals $1,000,000.The company estimates that if its sales were to increase 9.50%,its net income and EPS would increase 17.50%.What is the company's interest expense? Do not round intermediate calculations.

Accepted Answer

A)   $222,857
B)   $148,571
C)   $185,714
D)   $224,714
E)   $143,000 C

Question 2

If a firm uses debt financing (Debt ratio = 0.40)and sales change from the current level,which of the following statements is CORRECT?

Accepted Answer

A)   The percentage change in operating income (EBIT) resulting from the change in sales will exceed the percentage change in net income.
B)   The percentage change in EBIT will equal the percentage change in net income.
C)   The percentage change in net income relative to the percentage change in sales (and in EBIT) will not depend on the interest rate paid on the debt.
D)   The percentage change in operating income will be less than the percentage change in net income.
E)   Since debt is used,the degree of operating leverage must be greater than 1. D

Question 3

Which of the following is a key benefit of using the degree of leverage concept in financial analysis?

Accepted Answer

A)   It allows decision makers a relatively clear assessment of the consequences of alternative actions.
B)   It establishes the optimal capital structure for the firm.
C)   It shows how a given change in leverage will affect sales.
D)   It identifies,with certainty,the future net income based upon sales projections about the future.
E)   None of the above statements is correct. A

Question 4

Alvarez Technologies has sales of $3,000,000.The company's fixed operating costs total $500,000 and its variable costs equal 45.50% of sales,so the company's current operating income is $1,135,000.The company's interest expense is $500,000.What is the company's degree of total leverage (DTL)?

Accepted Answer

A)   2.8580
B)   2.6520
C)   2.2401
D)   2.5748
E)   2.6263

Question 5

A company has an EBIT of $4 million,and its degree of total leverage is 2.4.The firm's debt consists of $20 million in bonds with a YTM of 10.40%.The company is considering a new production process that will require an increase in fixed costs but a decrease in variable costs.If adopted,the new process will result in a degree of operating leverage of 1.4.The president wants to keep the degree of total leverage at 2.4.If EBIT remains at $4 million,what dollar amount of bonds must be outstanding to accomplish this (assuming the yield to maturity remains at 10.40% and is equal to the coupon rate)? Do not round intermediate calculations.

Accepted Answer

A)   $16,025,641
B)   $12,500,000
C)   $18,429,487
D)   $12,019,231
E)   $19,391,026

Question 6

Lincoln Lodging Inc.estimates that if its sales increase 10.00% then its net income will increase 14.50%.The company's EBIT equals $2.4 million,and its interest expense is $400,000.The company's operating costs include fixed and variable costs.What is the level of the company's fixed operating costs? Do not round your intermediate calculations.

Accepted Answer

A)   $480,000
B)   $455,000
C)   $400,000
D)   $500,000
E)   $420,000

Question 7

The Quick Company expects its sales to increase by 50% in the coming year.The firm's current EPS is $1.75.Its degree of operating leverage is 1.6,while its degree of financial leverage is 2.1.What is the firm's projected EPS for the coming year using the DTL approach? Do not round intermediate calculations.

Accepted Answer

A)   $4.69
B)   $4.50
C)   $3.99
D)   $4.36
E)   $5.53

Question 8

Stromburg Corporation makes surveillance equipment for intelligence organizations.Its sales are $75,000,000.Fixed costs,including research and development,are $40,000,000,while variable costs amount to 30% of sales.Stromburg plans an expansion which will generate additional fixed costs of $15,000,000,decrease variable costs to 25% of sales,and also permit sales to increase to $98,000,000.What is Stromburg's degree of operating leverage at the new projected sales level?

Accepted Answer

A)   3.8141
B)   4.4100
C)   3.9730
D)   3.0989
E)   4.0127

Question 9

Bell Brothers has $3,000,000 in sales.Fixed costs are estimated to be $100,000 and variable costs are equal to 50.00% of sales.The company has $1,000,000 in debt outstanding at a before-tax cost of 9.00%.If Bell Brothers' sales were to increase by 20.00%,how much of a percentage increase would you expect in the company's net income? Do not round intermediate calculations.

Accepted Answer

A)   18.09%
B)   22.90%
C)   20.15%
D)   28.40%
E)   24.73%

Question 10

Your firm's EPS last year was $1.00.You expect sales to increase by 32.50% during the coming year.If your firm has a degree of operating leverage equal to 1.25 and a degree of financial leverage equal to 3.50,then what is its expected EPS? Do not round intermediate calculations.

Accepted Answer

A)   $2.35
B)   $2.42
C)   $2.25
D)   $2.64
E)   $1.99

Question 11

Assume that a firm currently has EBIT of $2,000,000,a degree of total leverage of 7.500,and a degree of financial leverage of 1.875.If sales decline by 20% next year,then what will be the firm's expected EBIT in one year? Do not round intermediate calculations.

Accepted Answer

A)   $464,000
B)   $400,000
C)   $488,000
D)   $372,000
E)   $324,000

Question 12

Maxvill Motors has annual sales of $14,200.Its variable costs equal 60% of its sales and its fixed costs equal $1,000.If the company's sales increase 10%,what will be the percentage increase in the company's earnings before interest and taxes (EBIT)?

Accepted Answer

A)   13.47%
B)   12.14%
C)   11.29%
D)   12.62%
E)   11.65%

Question 13

Kulwicki Corporation wants to determine the effect of an expansion of its sales on its operating income (EBIT).The firm's current degree of operating leverage is 4.50.It projects new unit sales to be 170,000,an increase of 45,000 over last year's level of 125,000 units.Last year's EBIT was $60,000.Based on a degree of operating leverage of 4.50,what is this year's expected EBIT with the increase in sales?

Accepted Answer

A)   $157,200
B)   $138,336
C)   $196,500
D)   $193,356
E)   $147,768

Question 14

Which of the following statements is CORRECT?

Accepted Answer

A)   The degree of operating leverage (DOL) depends on a company's fixed costs,variable costs,and sales.The DOL formula assumes (1) that fixed costs are constant and (2) that variable costs are a constant proportion of sales.
B)   The degree of total leverage (DTL) is equal to the DOL plus the degree of financial leverage (DFL) .
C)   Arithmetically,financial leverage and operating leverage offset one another so as to keep the degree of total leverage constant.Therefore,the formula shows that the greater the degree of financial leverage,the smaller the degree of operating leverage.
D)   For a given change in sales,the corresponding percentage change in net income could be more or less than the percentage change in operating income.
E)   The degree of total leverage (DTL) is equal to the DFL divided by the degree of operating leverage (DOL) .

Question 15

A company currently sells 75,000 units annually.At this sales level,its EBIT is $4 million,and its degree of total leverage is 2.0.The firm's debt consists of $15 million in bonds with a 9.5% coupon.The company is considering a new production method which will entail an increase in fixed costs but a decrease in variable costs,and will result in a degree of operating leverage of 1.750.The president,who is concerned about the stand-alone risk of the firm,wants to keep the degree of total leverage at 2.0.If EBIT remains at $4 million,what dollar amount of bonds must be retired to accomplish this? Do not round intermediate calculations.

Accepted Answer

A)   $10,418,421.05
B)   $10,905,263.16
C)   $9,736,842.11
D)   $11,684,210.53
E)   $7,497,368.42

Question 16

The use of financial leverage by the firm has a potential impact on which of the following?

Accepted Answer

A)   1,3,5
B)   1,2,5
C)   2,3,5
D)   2,3,4,5
E)   1,2,3,5

Question 17

The degree of operating leverage has which of the following characteristics?

Accepted Answer

A)   The closer the firm is operating to the breakeven quantity,the smaller the DOL.
B)   A change in quantity demanded will produce the same percentage change in EBIT as an identical change in price per unit of output,other things held constant.
C)   The DOL is not a fixed number for a given firm,but will depend upon the time zero values of the economic variable Q (Quantity) ,P (Price) ,and V (Volume) .
D)   The DOL relates the change in net income to the change in operating income.
E)   If the firm has no debt,the DOL will equal 1.

Question 18

PQR Manufacturing Corporation has $1,500,000 in debt outstanding.The company's before-tax cost of debt is 10%.Sales for the year totaled $3,500,000 and variable costs were 60% of sales.Net income was equal to $600,000 and the company's tax rate was 40%.If PQR's degree of total leverage is equal to 1.40,what is its degree of operating leverage? Do not round intermediate calculations.

Accepted Answer

A)   0.9496
B)   1.0713
C)   1.0470
D)   1.5217
E)   1.2174

Question 19

Monroe Corporation currently sells 150,000 units a year at a price of $4.00 a unit.Its variable costs are approximately 35.00% of sales,and its fixed costs amount to 50.00% of revenues at its current output level.Although fixed costs are based on revenues at the current output level,the cost level is fixed.What is Monroe's degree of operating leverage in sales dollars?

Accepted Answer

A)   4.3767
B)   3.4667
C)   5.4167
D)   4.7667
E)   4.3333

Question 20

The "degree of leverage" concept is designed to show how changes in sales will affect EBIT and EPS.If a 30.00% increase in sales causes EPS to increase from $1.00 to $1.50,and if the firm uses no debt,then what is its degree of operating leverage? Do not round intermediate calculations.

Accepted Answer

A)   1.2500
B)   1.5667
C)   2.0333
D)   1.6667
E)   1.3000

Exam 25: Degree of Leverage

If a firm uses debt financing (Debt ratio = 0.40) and sales change from the current level,which of the following statements is CORRECT?