Question 1

Assume the following facts about a single product firm: $\begin{array}{l}
\text {Selling price per unit }&=\$ 25.00 \
\text { Variable costs per unit}&=\$ 20.00 \
\text {Total annual fixed costs }&=\$ 30,000
\end{array}$ What is the firm's annual breakeven volume in sales revenues?
A) $6,000
B) $250,000
C) $150,000
D) $1,500

Accepted Answer

The breakeven volume in sales revenues is calculated by dividing the total fixed costs by the contribution margin per unit (selling price per unit minus variable cost per unit), then multiplying by the selling price per unit. Here, it is $(\$30,000 / (\$25 - \$20)) \times \$25 = \$150,000$.

Question 2

Assume the following selected financial information about a firm that is about to restructure capital by exchanging equity for debt: $\begin{array}{ll}
\text { Present debt level }&=\$0\
\text { Proposed equity for debt swap }&=\$1,500,000\
\text { Interest rate on debt }&=6\%\\text { Corporate tax rate }&=40\%\\text { Market value of the firm's ecuity }&=\$2,400,000
\end{array}$
 Which of following would be true as a result of the restructuring according to the Modigliani-Miller model with taxes but without bankruptcy costs?
A) The new debt would contribute $600,000 to the value of equity due to its tax effect.
B) The market value of the remaining equity would be $1,500,000.
C) The total value of the firm would increase to $3,000,000.
D) All of the above.

Accepted Answer

The Modigliani-Miller model with taxes but without bankruptcy costs predicts that the total value of the firm will remain the same after the restructuring. The new debt will contribute $600,000 to the value of equity due to its tax effect, and the market value of the remaining equity will be $1,500,000.

Question 3

If a firm's degree of operating leverage is 8, what percentage change in sales revenue is required to double the firm's EBIT?
A) 100%
B) 8%
C) 12.5%
D) None of the above

Accepted Answer

Degree of operating leverage (DOL) = % change in EBIT / % change in sales revenue

Given DOL = 8, we need to find the % change in sales revenue required to double EBIT.

Let X be the % change in sales revenue required to double EBIT.

2EBIT = EBIT + (DOL*X*EBIT)

2 = 1 + (8*X)

X = 0.125 or 12.5%

Therefore, option C is correct.

Question 4

Last year Avator's operating income (EBIT) increased by 22 percent while its dollar sales increased by 15%. What is Avator's degree of operating leverage (DOL)?
A) .68
B) 2.0
C) 1.47
D) .32

Accepted Answer

DOL = % change in EBIT / % change in sales

Dollar sales increased by 15%, so we can assume the initial sales were 100%, and 115% after the increase. Therefore, the % change in sales is 15%.

Operating income (EBIT) increased by 22%, so if we assume the initial EBIT was 100, it increased to 122. Therefore, the % change in EBIT is 22%.

DOL = 22 / 15 = 1.47.

Therefore, the correct answer is C) 1.47.

Question 5

Kermit's Hardware's (KH) fixed operating costs are $20.8 million and its variable cost ratio is 0.30. The firm has $10 million in bonds outstanding with a coupon interest rate of 9%. KH has 200,000 shares of common stock outstanding. The firm has revenues of $32.2 million and its marginal tax rate is 40%. Compute KH's degree of total leverage.
A) 26.8
B) 5.5
C) 29.1
D) 4.7

Accepted Answer

The answer of Kermit's Hardware's (KH) fixed operating costs are...

Question 6

Dittmar Corp. is considering an operational change that will increase its DOL from 2.0 to 3.0. It will be funding this change with debt so that its DFL will increase from 1.2 to 1.5. Analysts believe that the overall change could increase sales by as much as 10% if it is successful, but could decrease sales by 6% if it is not successful. What is the range of possible changes in EPS based on this information?
A) Decrease of 18% to an increase of 30%
B) Decrease of 9% to an increase of 15%
C) Decrease of 6% to an increase of 10%
D) Decrease of 27% to an increase of 45%
E) Decrease of 24% to an increase of 40%

Accepted Answer

The range of possible changes in EPS can be calculated using the Degree of Total Leverage (DTL), which is the product of the Degree of Operating Leverage (DOL) and the Degree of Financial Leverage (DFL). The initial DTL is 2.0 * 1.2 = 2.4, and the new DTL after the changes will be 3.0 * 1.5 = 4.5. The percentage change in EPS for a given percentage change in sales is equal to the percentage change in sales times the DTL. Therefore, for a 10% increase in sales, the increase in EPS would be 10% * 4.5 = 45%. For a 6% decrease in sales, the decrease in EPS would be 6% * 4.5 = 27%. Thus, the range of possible changes in EPS is a decrease of 27% to an increase of 45%.

Question 7

A firm's degree of financial leverage is 1.5 and the degree of operating leverage is 2.0. What is their degree of total leverage?
A) 9.0
B) 3.0
C) 4.5
D) None of the above

Accepted Answer

The degree of total leverage is calculated by multiplying the degree of financial leverage (1.5) by the degree of operating leverage (2.0), which equals 3.0.

Question 8

Porter Productions sells video tapes for $15.00 each. Their variable cost per unit is $9.00. In addition, they incur $180,000 in fixed costs each year. What is the Porter's annual breakeven point in sales revenue?
A) $30,000
B) $180,000
C) $300,000
D) $450,000
E) $720,000

Accepted Answer

The breakeven point in sales revenue is calculated by dividing the fixed costs by the contribution margin ratio. The contribution margin per unit is the selling price minus the variable cost ($15 - $9 = $6). The contribution margin ratio is the contribution margin per unit divided by the selling price ($6 / $15 = 0.4). To find the breakeven point in sales revenue, divide the fixed costs by the contribution margin ratio ($180,000 / 0.4 = $450,000).

Question 9

Assume the following selected financial information about a firm that is about to restructure capital by exchanging equity for debt: $\begin{array}{ll}
\text {Present debt level }&=\$ 0\
\text {Proposed equity for debt exchange }&=\$ 1,000,000\
\text { Present EBIT}&=\$ 500,000\
\text { Interest rate on debt}&=6 \% \
\text { Corporate tax rate}&=40 \%\
\text {Current market value of equity }&=\$ 3,000,000 \
\end{array}$
 What is the market value of the firm's equity after the restructuring according to the Modigliani-Miller model with taxes but without bankruptcy costs?
A) $2,000,000
B) $2,264,000
C) $2,400,000
D) None of the above

Accepted Answer

The answer of Assume the following selected financial information about...

Question 10

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

Accepted Answer

DOL = (percentage change in EBIT) / (percentage change in sales)
1.5 = (DOL) / 0.11
DOL = 0.11 x 1.5 = 0.165

DFL = (percentage change in EPS) / (percentage change in EBIT)
DFL = 0.34 / 0.165 = 2.06

Therefore, the answer is B.

Question 11

Zahn Enterprises pays $3 million annually to its bondholders and $7.5 million annual to its stockholders. The required rates of return are 9 percent and 15 percent, respectively, by the bondholders and stockholders. What is the value of Zahn Enterprises?
A) $1.40 million
B) $10.50 million
C) $16.66 million
D) $83.33 million

Accepted Answer

The value of Zahn Enterprises can be calculated by dividing the annual payments to bondholders and stockholders by their respective required rates of return. For bondholders: $3 million / 9% = $33.33 million. For stockholders: $7.5 million / 15% = $50 million. Adding these values together gives $33.33 million + $50 million = $83.33 million.

Question 12

Porter Productions sells video tapes for $15.00 each. Their variable cost per unit is $9.00. In addition, they incur $180,000 in fixed costs each year. At 40,000 units of sale, what is Porter's degree of operating leverage (DOL)?
A) 1.33
B) 2.50
C) 3.00
D) 4.00
E) 6.00

Accepted Answer

The answer of Porter Productions sells video tapes for $15.00...

Question 13

A firm's degree of financial leverage is 2 and the degree of operating leverage is 2.5. An uncertain economic outlook could mean a 10% reduction in the current level of sales. The firm is considering an increase of its degree of financial leverage to 3 by issuing additional debt. The degree of total leverage suggests that the sales volatility could result in a decrease in EPS of as much as:
A) 5.5% if the additional debt is not issued.
B) 7.5% if the additional debt is issued.
C) 55% if the additional debt is issued.
D) 75% if the additional debt is issued.

Accepted Answer

The answer of A firm's degree of financial leverage is...

Question 14

Porter Productions sells video tapes for $15.00 each. Their variable cost per unit is $9.00. In addition, they incur $180,000 in fixed costs each year. How many units will Porter have to produce and sell in order to generate an operating income (revenues minus expenses) of $54,000?
A) 9,000 units
B) 18,000 units
C) 30,000 units
D) 39,000 units
E) 54,000 units

Accepted Answer

Operating income = Revenues - Expenses
We need to calculate the number of units sold to generate an operating income of $54,000.
Let x be the number of units sold.
Revenues = Selling price * Number of units sold = $15x
Expenses = Variable cost per unit * Number of units sold + Fixed costs = $9x + $180,000
Operating income = $15x - ($9x + $180,000) = $6x - $180,000
We need to solve for x when operating income is $54,000:
$6x - $180,000 = $54,000
$6x = $234,000
x = 39,000 units
Therefore, Porter needs to produce and sell 39,000 units to generate an operating income of $54,000.

Question 15

Illinois Tool Company's (ITC) degree of total leverage (DTL) 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.
A) 60%
B) 50%
C) 32%
D) None of the above

Accepted Answer

The degree of total leverage (DTL) is used to measure the sensitivity of the company's earnings per share (EPS) to a change in sales. The formula for calculating the percentage change in EPS given a percentage change in sales is: Percentage Change in EPS = DTL × Percentage Change in Sales. Given that the DTL is 3.00 and the forecasted sales increase is 20 percent, the calculation would be: Percentage Change in EPS = 3.00 × 20% = 60%.

Question 16

If a company sells 20,000 units at $20 each, has fixed costs of $50,000 and a variable cost of $10 per unit, what is their degree of operating leverage (DOL)?
A) 1.6
B) 2.5
C) 1.33
D) 1.7

Accepted Answer

The answer of If a company sells 20,000 units at...

Question 17

A firm's EPS increased 27% on a 12% increase in sales. At the same time its EBIT increased 8% what is the firm's DFL?
A) 1.50
B) 3.36
C) 1.34
D) 0.67

Accepted Answer

The Degree of Financial Leverage (DFL) is calculated as the percentage change in EPS divided by the percentage change in EBIT. Given that EPS increased by 27% and EBIT increased by 8%, DFL = 27% / 8% = 3.375, which rounds to 3.36, making option B correct.

Question 18

A firm's degree of financial leverage is 2 and the degree of operating leverage is 2.5. What is their degree of total leverage?
A) 6.0
B) 4.5
C) 5.0
D) None of the above

Accepted Answer

The degree of total leverage is the product of the degree of financial leverage and the degree of operating leverage. Thus, the degree of total leverage is 2 x 2.5 = 5.0. Therefore, the correct answer is C.

Question 19

If a company sells 10,000 units at $25 each, has fixed costs of $20,000, and a variable cost of $20 per unit, what is its degree of operating leverage (DOL)?
A) 1.67
B) 2.5
C) 2.0
D) 1.6

Accepted Answer

The answer of If a company sells 10,000 units at...

Question 20

Illinois Tool Company's (ITC) fixed operating costs are $1,260,000. Its variable costs average 70% of the price of its products. The firm currently has sales revenue of $9 million per year. What is ITC's degree of operating leverage?
A) 1.60
B) 1.875
C) 3.0
D) None of the above

Accepted Answer

The degree of operating leverage (DOL) is calculated as: DOL = 1 + (Fixed Operating Costs / (Sales - Variable Costs)). Given that fixed operating costs are $1,260,000, sales are $9,000,000, and variable costs are 70% of sales (which means variable costs = 0.7 * $9,000,000 = $6,300,000), we can calculate the DOL as follows: DOL = 1 + ($1,260,000 / ($9,000,000 - $6,300,000)) = 1 + ($1,260,000 / $2,700,000) = 1 + 0.4667 = 1.4667. However, since none of the provided options exactly match this calculation, it appears there may have been a mistake in the calculation or interpretation of the options. The correct approach to find the DOL involves understanding that it measures the sensitivity of a company's operating income to its sales. The correct calculation should consider the formula and the given data accurately. Given the discrepancy, a more detailed review of the calculation process and the assumptions might be necessary to align with the provided options.

Quiz 14: Capital Structure and Leverage

Assume the following facts about a single product firm: $\begin{array}{l}\text {Selling price per unit }&=\$ 25.00 \\\text { Variable costs per unit}&=\$ 20.00 \\\text {Total annual fixed costs }&=\$ 30,000\end{array}$ What is the firm's annual breakeven volume in sales revenues?

If a firm's degree of operating leverage is 8, what percentage change in sales revenue is required to double the firm's EBIT?

Last year Avator's operating income (EBIT) increased by 22 percent while its dollar sales increased by 15%. What is Avator's degree of operating leverage (DOL) ?

A firm's degree of financial leverage is 1.5 and the degree of operating leverage is 2.0. What is their degree of total leverage?

Porter Productions sells video tapes for $15.00 each. Their variable cost per unit is $9.00. In addition, they incur $180,000 in fixed costs each year. What is the Porter's annual breakeven point in sales revenue?

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?

Zahn Enterprises pays $3 million annually to its bondholders and $7.5 million annual to its stockholders. The required rates of return are 9 percent and 15 percent, respectively, by the bondholders and stockholders. What is the value of Zahn Enterprises?

Porter Productions sells video tapes for $15.00 each. Their variable cost per unit is $9.00. In addition, they incur $180,000 in fixed costs each year. At 40,000 units of sale, what is Porter's degree of operating leverage (DOL) ?

Porter Productions sells video tapes for $15.00 each. Their variable cost per unit is $9.00. In addition, they incur $180,000 in fixed costs each year. How many units will Porter have to produce and sell in order to generate an operating income (revenues minus expenses) of $54,000?

Illinois Tool Company's (ITC) degree of total leverage (DTL) 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.

If a company sells 20,000 units at $20 each, has fixed costs of $50,000 and a variable cost of $10 per unit, what is their degree of operating leverage (DOL) ?

A firm's EPS increased 27% on a 12% increase in sales. At the same time its EBIT increased 8% what is the firm's DFL?

A firm's degree of financial leverage is 2 and the degree of operating leverage is 2.5. What is their degree of total leverage?

If a company sells 10,000 units at $25 each, has fixed costs of $20,000, and a variable cost of $20 per unit, what is its degree of operating leverage (DOL) ?

Illinois Tool Company's (ITC) fixed operating costs are $1,260,000. Its variable costs average 70% of the price of its products. The firm currently has sales revenue of $9 million per year. What is ITC's degree of operating leverage?