Deck 13: Leverage and Capital Structure

Question 1

Generally, decreases in leverage result in increased return and risk, whereas increases in leverage result in decreased return and risk.

Answer 1

False

Question 2

Breakeven analysis is used by a firm to determine the level of operations necessary to cover all fixed operating costs and to evaluate the profitability associated with various levels of production.

Answer 2

False

Question 3

The dollar breakeven sales level can be solved for by dividing fixed costs by the dollar contribution margin.

Answer 3

False

Question 4

At the operating breakeven point, the sales revenue is equal to the sum of the fixed and variable operating costs.

Question 5

In finding the operating breakeven point, it is important to divide the cost of goods sold and operating expenses into fixed and variable operating costs.

Question 6

Leverage results from the use of equity to magnify returns to a firm's owners.

Question 7

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

Question 8

The amount of leverage in a firm's capital structure-the mix of long-term debt and equity maintained by the firm-can significantly affect its value by affecting return and risk.

Question 9

Financial leverage is concerned with the relationship between a firm's earnings after interest and taxes and its common stock earnings per share.

Question 10

Both operating and financial leverage result in the magnification of return as well as risk.

Question 11

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.

Question 12

While operating leverage results only in a magnification of returns, financial leverage results only in a magnification of risk.

Question 13

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

Question 14

Operating leverage is concerned with the relationship between a firm's sales revenue and its financial expenses.

Question 15

The levels of fixed-cost assets and funds that management selects affect the variability of returns.

Question 16

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

Question 17

The dollar breakeven sales level can be solved for by dividing fixed costs by the contribution margin ratio.

Question 18

A firm's operating breakeven point is the level of sales necessary to cover all fixed operating costs.

Question 19

Earnings before interest and taxes are positive above the operating breakeven point, and a loss occurs below it.

Question 20

Total leverage is concerned with the relationship between a firm's sales revenue and its common stock earnings per share.

Question 21

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.

Question 22

Earnings before interest and taxes (EBIT) is a descriptive label for ________.

A) operating profits
B) net profits before taxes
C) earnings per share
D) gross profits

Question 23

An increase in cost (fixed cost or variable cost) tends to increase the operating breakeven point, whereas an increase in the sales price per unit will decrease the operating breakeven point.

Question 24

The contribution margin is defined as the percent of each sales dollar that remains after satisfying fixed operating costs.

Question 25

The operating breakeven point can be found by solving for the sales level that just covers total fixed and variable costs.

Question 26

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

A) decreased; increased
B) decreased; decreased
C) increased; increased
D) increased; decreased

Question 27

________ costs require the payment of a specified amount in each accounting period.

A) Operating
B) Variable
C) Semi-variable
D) Fixed

Question 28

The breakeven point in dollars can be computed by dividing the contribution margin into the variable operating costs.

Question 29

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.

Question 30

One of the limitations of breakeven analysis is its short-term time horizon. A large outlay in the current financial period could significantly raise the firm's breakeven point, while the benefits may occur over a period of years.

Question 31

The three basic types of leverage are ________.

A) operating, production, and financial
B) operating, production, and total
C) production, financial, and total
D) operating, financial, and total

Question 32

Which of the following is a fixed cost?

A) inventory
B) rent
C) delivery costs
D) direct labor

Question 33

A firm's ________ is the level of sales necessary to cover all operating costs, i.e., the point at which EBIT equals zero.

A) cash breakeven point
B) financial breakeven point
C) operating breakeven point
D) total breakeven point

Question 34

________ analysis is a technique used to assess the returns associated with various cost structures and levels of sales.

A) Time-series
B) Marginal
C) Breakeven
D) Ratio

Question 35

In case of a manufacturing organization, which of the following is a variable cost that varies directly with the sales volume?

A) interest cost
B) dividend cost
C) shipping cost
D) rental cost

Question 36

The use of a dollar breakeven point is important when a firm has more than one product, especially when each product is selling at a different price.

Question 37

Which of the following is true of leverage?

A) It refers to the effects that operating and financial fixed costs have on the returns that shareholders earn.
B) It is associated with risks which are out of the control of managers.
C) It includes the effect of operating fixed costs on the returns of shareholders and not the financial fixed costs.
D) It is used to evaluate the profitability associated with various levels of sales.

Question 38

________ refers to the effects that fixed costs have on the returns that shareholders earn.

A) Purchase power parity
B) Leverage
C) Business risk
D) Pecking order theory

Question 39

________ costs are a function of time, not sales, and are typically contractual.

A) Fixed
B) Semi-variable
C) Variable
D) Operating

Question 40

________ results from the use of fixed-cost assets or funds to magnify returns to a firm's owners.

A) Long-term debt
B) Equity
C) Leverage
D) Capital structure

Question 41

A major assumption of breakeven analysis and one which causes severe limitations in its use is that ________.

A) fixed costs really are fixed
B) total revenue is nonlinear
C) revenues and operating costs are linear
D) all costs are really semi-variable

Question 42

One function of breakeven analysis is to ________.

A) determine the profit attributable to each stockholder
B) evaluate the effect of leverage on a firm's risks and returns
C) evaluate the profitability of various sales levels
D) determine the amount of financing needed by the firm

Question 43

If a firm's sale price per unit decreases, the firm's ________.

A) operating breakeven point will decrease
B) operating breakeven point will increase
C) variable costs per unit will decrease
D) variable costs per unit will increase

Question 44

If a firm's fixed financial costs decrease, the firm's operating breakeven point will ________.

A) decrease
B) increase
C) remain unchanged
D) change based on the sale price per unit

Question 45

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 ________.

A) 7,500
B) 15,030
C) 5,003
D) 3,754

Question 46

At the operating breakeven point, ________ equals zero.

A) sales revenue
B) fixed operating costs
C) variable operating costs
D) earnings before interest and taxes

Question 47

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

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

Question 48

The preferred approach to breakeven analysis for a multiproduct firm is the ________.

A) breakeven point expressed in units
B) breakeven point expressed in dollars
C) cash breakeven point
D) overall breakeven point

Question 49

Mark must buy four new tires for his car. He is considering buying tires that are $25 a piece more than his regular brand, because the higher priced tires are supposed to increase his miles per gallon by 20%. If the tires are good for 48,000 miles and Mark drives an average of 1,000 miles per month, gas costs $2.50 per gallon over the next 4 years, and Mark's car gets 30 miles to the gallon now (on the old tires), should Mark purchase the more expensive tires?

A) Yes, because Mark will save about $660 dollars in gas over the four years but the new tires will only be $100 more.
B) Yes, because Mark will save about $560 dollars in gas over the four years but the new tires will only be $100 more.
C) No, because Mark will only save about $60 dollars in gas over the four years but the new tires will only be $100 more.
D) No, because Mark will only save about $90 dollars in gas over the four years but the new tires will only be $100 more.

Question 50

A firm has fixed operating costs of $150,000, total sales of $1,500,000, and total variable costs of $1,275,000. The firm's operating breakeven point in dollars is ________.

A) $150,000
B) $176,471
C) $1,000,000
D) $1,425,000

Question 51

Breakeven analysis is used by a firm ________.

A) to determine the level of operations necessary to cover all fixed operating costs
B) to determine the least cost of producing goods and services
C) to evaluate the profitability associated with various levels of sales
D) to determine the demand of a product

Question 52

Carol's Dolls has fixed operating costs of $25,000. Its sale price is $55 per doll, and its variable operating cost is $30 per doll. It sells 3,000 dolls per month. The firm's earnings before interest and taxes is ________.

A) $37,500
B) $55,000
C) $75,000
D) $50,000

Question 53

A firm's operating breakeven point is the point at which ________.

A) total operating costs equal total fixed costs
B) total operating costs are zero
C) EBIT is less than sales
D) EBIT is zero

Question 54

If a firm's variable costs per unit increase,the firm's ________.

A) financial breakeven point will decrease
B) operating breakeven point will increase
C) sale price per unit will decrease
D) fixed costs per unit will increase

Question 55

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 ________.

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

Question 56

________ is 100 percent minus total variable operating costs as a percentage of total sales.

A) Profit margin
B) Contribution margin
C) Expense ratio
D) Fixed coverage ratio

Question 57

A firm has fixed operating costs of $10,000, the sale price per unit of its product is $25, and its variable cost per unit is $15. The firm's operating breakeven point in units is ________ and its breakeven point in dollars is ________.

A) 1,000; $6,250
B) 400; $10,000
C) 400; $25,000
D) 1,000; $25,000

Question 58

A firm has fixed operating costs of $25,000, a per unit sales price of $5, and a variable cost per unit of $3. What is its operating breakeven point if it targets net operating income of $10,000?

A) 12,500 units
B) 15,000 units
C) 17,500 units
D) 25,000 units

Question 59

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 dollars is ________.

A) $125,495
B) $112,425
C) $108,995
D) $110,495

Question 60

If a firm's fixed operating costs decrease, the firm's ________.

A) operating breakeven point will decrease
B) operating breakeven point will increase
C) sale price per unit will decrease
D) sale price per unit will increase

Question 61

Whenever the percentage change in EBIT resulting from a given percentage change in sales is greater than the percentage change in sales, operating leverage exists.

Question 62

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.

Question 63

Operating leverage results from the existence of operating costs in a firm's income stream.

Question 64

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.

Question 65

The base level of EBIT must be held constant to compare the financial leverage associated with different levels of fixed financial costs.

Question 66

Operating leverage is present when a firm has fixed operating costs.

Question 67

When a firm has fixed operating costs, operating leverage is present. In that case, an increase in sales results in a more-than-proportional increase in EBIT, and a decrease in sales results in a more-than-proportional decrease in EBIT.

Question 68

The relationship between operating and financial leverage is additive rather than multiplicative.

Question 69

Operating leverage may be defined as the potential use of fixed operating costs to magnify the effects of changes in sales on a firm's earnings before interest and taxes (EBIT).

Question 70

The effect of financial leverage is such that an increase in a firm's earnings before interest and taxes (EBIT) results in a more than proportional increase in the firm's earnings per share (EPS), while a decrease in the firm's EBIT results in a less than proportional decrease in EPS.

Question 71

Financial leverage may be defined as the potential use of variable financial costs to magnify the effects of changes in earnings before interest and taxes (EBIT) on a firm's earnings per share (EPS).

Question 72

Financial leverage results from the presence of variable financial costs in a firm's income stream.

Question 73

The base level of sales must be held constant to compare the total leverage associated with different levels of fixed costs.

Question 74

Whenever the percentage change in earnings before interest and taxes resulting from a given percentage change in sales is greater than the percentage change in sales, operating leverage exists.

Question 75

The total leverage measures the combined effect of operating and financial leverage on a firm's risk.

Question 76

Whenever the percentage change in earnings per share (EPS) resulting from a given percentage change in sales is greater than the percentage change in sales, financial leverage exists.

Question 77

The closer the base sales level used is to the operating breakeven point, the smaller the operating leverage.

Question 78

Comparison of the degree of operating leverage of two firms is valid only when the base level of sales used for each firm is the same.

Question 79

The degree of operating leverage will increase if a firm decides to compensate its sales representatives with a fixed salary and bonus rather than with a pure percent-of-sales commission.

Question 80

Total leverage exists whenever the percentage change in earnings per share (EPS) resulting from a given percentage change in sales is greater than the percentage change in sales.