Deck 5: Operating and Financial Leverage

Question 1

Contribution margin represents the amount of sales left over after fixed costs are paid.

Answer 1

False

Question 2

Contribution margin is equal to fixed costs minus variable costs.

Answer 2

False

Question 3

The difference between variable cost and fixed cost is that the cost amount fluctuates differently based on how many units are sold.

Answer 3

True

Question 4

Financial leverage emphasizes the impact of using debt in the business.

Question 5

Operating leverage will change when a firm alters the mix of fixed capital resources and variable labor that it uses.

Question 6

To determine the break-even point for a company, you divide the contribution margin by the fixed costs.

Question 7

Property taxes and depreciation expense are examples of variable costs.

Question 8

Sales commissions and raw materials are variable costs.

Question 9

Operating leverage determines how income from operations is to be divided between debt holders and stockholders.

Question 10

Operating leverage works best when product volume is increasing.

Question 11

A lower sales price for the firm's product will reduce the firm's break-even point.

Question 12

Break-even analysis helps a company determine what amount of quantity it needs to sell in order to reach zero profit.

Question 13

The contribution margin is equal to sales price per unit minus total costs per unit.

Question 14

The use of financial leverage must consider both risk and maximizing profit.

Question 15

"Operating leverage" is the use of fixed costs to magnify returns at high levels of operation.

Question 16

As the contribution margin rises, the break-even point goes down.

Question 17

If economic conditions were expected to be favorable, an investor would likely prefer a firm with a low degree of leverage.

Question 18

Operating leverage emphasizes the impact of using fixed assets in the business.

Question 19

When a business decides to go with a heavy commitment to fixed costs in the manufacturing process, they are employing operating leverage.

Question 20

When a business decides to use debt in financing their firm, they are engaging in financial leverage.

Question 21

The degree of operating leverage is a number indicating the relationship between the percentage change in sales to the percentage change in earnings per share.

Question 22

Degree of operating leverage should be computed only over a profitable range of business operations.

Question 23

A firm with a high degree of financial leverage could face financial difficulty even though it is in a stable industry.

Question 24

Management should tailor the use of leverage to meet the company's own risk-taking desires.

Question 25

The lower a firm's break-even point, the lower amount of quantity which needs to be sold in order to reach a profit of zero.

Question 26

Linear break-even analysis assumes that the change in costs have the same relationship with the change in volume.

Question 27

The closer a firm is to its break-even point, the lower the degree of operating leverage it will be.

Question 28

Operating leverage primarily affects the asset side of the balance sheet, while financial leverage affects the liabilities and net worth side of the balance sheet.

Question 29

Operating income is not the same thing as earnings before interest and taxes (EBIT).

Question 30

Linear break-even analysis and operating leverage are only valid within a relevant range of unit production.

Question 31

Financial leverage primarily affects the asset side of the balance sheet.

Question 32

Cash break-even analysis eliminates the non-cash charges from fixed costs in order to obtain the amount of quantity sold which is necessary in order for cash inflow to equal the cash outflow.

Question 33

The lower a firm's break-even point, the better for the firm.

Question 34

The degree of financial leverage is not influenced by the interest rate on debt, only the amount borrowed.

Question 35

Based on the example in the textbook, the calculation below is of a leveraged firm.
DOL = $\frac{\text {Percent change in operating income }}{\text {Percent change in unit volume }}$ = $\frac { \frac { \$ 8,000 } { \$ 20,000 } \times 100 } { \frac { 20,000 } { 80,000 } \times 100 }$ = $\frac { 40 \% } { 25 \% }$ = 1.6

Question 36

The use of debt is not typically needed for firms in industries that offer some degree of stability, are in a positive stage of growth, and are operating in favorable economic conditions.

Question 37

The degree of financial leverage measures the percentage change in earnings per share (EPS) for every percentage change in earnings before interest and taxes (EBIT).

Question 38

Managers who are risk-averse and uncertain about the future would most likely minimize combined leverage.

Question 39

Based on the example in the textbook, the calculation below is of a conservative firm.
DOL = $\frac{\text {Percent change in operating income }}{\text {Percent change in unit volume }}$ = $\frac { \frac { \$ 24,000 } { \$ 36,000 } \times 100 } { \frac { 20,000 } { 80,000 } \times 100 }$ = $\frac { 67 \% } { 25 \% }$ = 2.7

Question 40

If a firm has a degree of financial leverage (DFL) of 2.0, earnings per share will change 2% for every 1% change in sales volume.

Question 41

The concept of operating leverage involves the use of ________ to magnify returns at high levels of operation.

A) fixed costs
B) variable costs
C) marginal costs
D) semivariable costs

Question 42

If a firm has fixed costs of $60,000, a sales price of $7.00 per unit, and a break-even point of 25,000 units, the variable cost per unit is ________.

A) $5.00
B) $4.60
C) $5.40
D) $4.00

Question 43

A highly automated plant would generally have

A) more variable than fixed costs.
B) more fixed than variable costs.
C) all fixed costs.
D) all variable costs.

Question 44

A firm with a high degree of combined leverage will, other things being equal, experience higher earnings in the expansionary part of the business cycle.

Question 45

Which of the following questions does break-even analysis attempt to address?

A) How much do changes in volume affect costs and profits?
B) At what point does the firm have zero profit?
C) What is the most efficient level of fixed assets to employ?
D) All of the options

Question 46

Degree of combined leverage considers the impact of a change in volume on the change in operating income.

Question 47

Operating leverage influences the bottom half of the income statement while financial leverage deals with the top half.

Question 48

If fixed costs rise while other variables stay constant

A) the break-even point rises.
B) the degree of operating leverage increases.
C) total profit declines.
D) All of the options are true.

Question 49

The break-even point can be calculated as

A) variable costs divided by contribution margin per unit.
B) total costs divided by contribution margin per unit.
C) variable costs times contribution margin per unit.
D) fixed costs divided by contribution margin per unit.

Question 50

At the break-even point, a firm's profits are

A) greater than zero.
B) less than zero.
C) equal to zero.
D) Not enough information is given to determine.

Question 51

In order to conduct a cash break-even analysis, the analyst must add back depreciation from fixed costs.

Question 52

Firms with cyclical sales should employ a high degree of leverage.

Question 53

If a firm has fixed costs of $85,000, a variable cost per unit of $10 and sales price per unit of $15, what is the firm's breakeven point in units?

A) 15,000 units
B) 17,000 units
C) 5,667 units
D) 3,400 units

Question 54

In break-even analysis, the contribution margin is defined as

A) sales price minus variable cost.
B) sales price minus fixed cost.
C) variable cost minus fixed cost.
D) fixed cost minus variable cost.

Question 55

If sales units exceeds the break-even point in units, the firm will experience

A) an operating loss.
B) an operating profit.
C) an increase in plant and equipment.
D) an increase in stock price.

Question 56

If the sales price per unit decreases because of competition but the cost structure remains the same

A) the break-even point rises.
B) the degree of combined leverage declines.
C) the degree of financial leverage declines.
D) All of the options are true.

Question 57

Reducing the number of outstanding shares will always increase financial leverage since earnings per share will be higher, all else stays the same.

Question 58

An example of an adjustment for a cash break-even analysis would be adding back increases in accounts receivable.

Question 59

If a firm sells 40,000 units and the contribution margin on the firm's single product is $4.00 per unit and fixed costs are $60,000, what will the firm's operating profit be at this level of sales volume?

A) $100,000
B) $30,000
C) $15,000
D) $145,000

Question 60

The degree of combined leverage is the sum of the degree of operating leverage and the degree of financial leverage.

Question 61

Which of the following statements regarding financial leverage are true.

A) financial leverage reflects the amount of debt used in the capital structure of the firm.
B) financial leverage primarily affects the right side of the balance sheet.
C) financial leverage determines how the operation is to be financed.
D) all of the above.

Question 62

If a firm has fixed costs of $50,000, a variable cost per unit of $5 and sales price per unit of $20, what is the firm's breakeven point in units?

A) 3,333 units
B) 10,000 units
C) 4,667 units
D) 3,334 units

Question 63

A high degree of operating leverage means

A) there are high labor costs.
B) there is high debt.
C) there is a large amount of equity.
D) there are high fixed costs.

Question 64

A weakness of break-even analysis is that it assumes

A) revenue and costs are a linear (constant) function of volume.
B) sales prices and costs increase when the economy is strong and confidence is high.
C) the cost of goods sold goes up as revenue increases.
D) None of the options are true.

Question 65

If a firm with $49,000 in fixed costs breaks even on 7,000 units, how many units must the firm sell to earn $30,000 in operating profit?

A) 30,000 units
B) 11,286 units
C) 15,824 units
D) There is not enough information to determine the unit sales required.

Question 66

Firms with a high degree of operating leverage are

A) easily capable of surviving large changes in sales volume.
B) usually trading off lower levels of risk for higher profits.
C) significantly affected by changes in interest rates.
D) trading off higher fixed costs for lower per-unit variable costs.

Question 67

Cash break-even analysis

A) is helpful in analyzing the short-term outlook of the firm, particularly when it is in trouble financially.
B) is important when analyzing long-term profitability.
C) includes depreciation expense as a fixed cost when calculating the degree of financial leverage.
D) None of the options are true.

Question 68

Conservatively leveraged Firm A and highly leveraged Firm B operate at the same level of earnings before interest and taxes. Which firm has a higher change in volume?

A) Firm A
B) Firm B
C) The change in volume does not affect the amount of leverage.
D) There is not enough information to answer the question.

Question 69

Davison Toaster Corp. sells its products for $150 per unit. It has the following costs:
$$\begin{array} { l r r r } \text { Rent } & \$ 115,000 \\\text { Factory labor } & \$ 20 \text { per writ } \\\text { Executive salaries } & \$ 200,000 \\\text { Raw materials } & \$ 6 \text { per witit }\end{array}$$
The break-even point is

A) less than 3,000 units.
B) 3,000 units.
C) more than 3,500 units.
D) Not enough information has been provided to determine the break-even point.

Question 70

Which of the following is true about the concept of leverage?

A) At the break-even point, operating leverage is equal to zero.
B) Combined leverage measures the impact of operating and financial leverage on EBIT.
C) Financial leverage measures the impact of fixed costs on earnings.
D) None of the options are true.

Question 71

Which of the following is concerned with the change in operating profit as a result of a change in unit volume?

A) Financial leverage
B) Break-even point
C) Operating leverage
D) Combined leverage

Question 72

The degree of operating leverage is computed as

A) percent change in operating profit divided by percent change in net income.
B) percent change in unit volume divided by percent change in operating profit.
C) percent change in EPS divided by percent change in operating income.
D) percent change in operating income divided by percent change in unit volume.

Question 73

A firm's break-even point will rise if

A) fixed costs decrease.
B) contribution margin increases.
C) sales price per unit rises.
D) variable cost per unit rises.

Question 74

Financial leverage deals with

A) the relationship of fixed and variable costs.
B) the relationship of debt and equity in the capital structure.
C) the entire income statement.
D) the entire balance sheet.

Question 75

If a firm has fixed costs of $30,000, a variable cost per unit of $.75, and a break-even point of 5,000 units, the sales price per unit is ________.

A) $2.50
B) $6.75
C) $4.00
D) $4.50

Question 76

A firm has operating profit of $15,000 on unit sales of 10,000 units. Fixed costs are $30,000. What is the firm's break-even in units?

A) Less than 6,000 units.
B) 6,000 units.
C) More than 6,000 units
D) There is not enough information to determine the unit break-even point.

Question 77

If a firm has a sales price per unit of $6.00, a variable cost per unit of $4.00, and a break-even point of 40,000 units, fixed costs are equal to ________.

A) $27,000
B) $90,000
C) $80,000
D) $50,000

Question 78

The degree of operating leverage may be defined as

A) the percent change in operating income divided by the percent change in unit volume.
B) Q(P − VC) divided by Q(P − VC) − FC.
C) S − TVC divided by S − TVC − FC.
D) All of the options are true.

Question 79

Firm A employs a high degree of operating leverage; Firm B takes a more conservative approach. Which of the following comparative statements about firms A and B is true?

A) Firm A has a lower break-even point than Firm B, but Firm A's profit grows faster after the breakeven.
B) Firm A has a higher break-even point than Firm B, but Firm A's profit grows slower after the breakeven.
C) Firm B has a lower break-even point than Firm A, but Firm A's profit grows faster after the breakeven.
D) Firm B has a lower break-even point than Firm A, and profit grows the same rate for both companies after the break-even point

Question 80

Loretta & Niece's fixed costs are $425,000, including $25,000 of depreciation expense. The price of each unit sold is $120, and the variable cost per unit is $60. How many units must the firm sell to reach the cash break-even point?

A) 6,667 units
B) 7,333 units
C) 7,083 units
D) 3,542 units