Question 1

Which of the following is not true about leverage?

Accepted Answer

The answer of Which of the following is not true...

Question 2

When a firm employs no debt

Accepted Answer

The answer of When a firm employs no debt
...

Question 3

Under which of the following conditions could the overuse of financial leverage be detrimental to the firm?

Accepted Answer

When there is cyclical demand for the firm's products, overusing financial leverage can be detrimental because high debt levels may lead to financial distress during downturns or low demand periods, making it difficult for the firm to meet its debt payments. In contrast, in a stable industry, during an upswing in the business cycle, or when there is a low interest cost compared to return on assets, the use of financial leverage may have greater benefits as it can help to increase profits and returns to shareholders.

Question 4

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

Accepted Answer

Operating leverage is concerned with the change in operating profit as a result of a change in volume. Financial leverage involves the use of debt to increase potential returns, while break-even point is the level of sales where total revenue equals total costs. Combined leverage is a combination of operating and financial leverage.

Question 5

The degree of operating leverage may be defined as

Accepted Answer

The degree of operating leverage can be calculated using any of the options given in the choices, so all the options are correct. Choice A uses the percentage change in operating income and unit volume, Choice B uses the formula for contribution margin ratio, and Choice C uses the formula for the break-even point.

Question 6

Heavy use of long-term debt may be beneficial in an inflationary economy because

Accepted Answer

Heavy use of long-term debt may be beneficial in an inflationary economy because the debt may be repaid in "cheaper" dollars, as the value of money decreases with inflation. This means that the amount owed in nominal terms would stay the same, but its real value would decrease, making it easier for the borrower to repay the debt.

Question 7

A conservative financing plan involves

Accepted Answer

A conservative financing plan involves a heavy reliance on equity. This is because the company wants to limit its financial risk and avoid taking on too much debt. By relying on equity, the company is not obligated to make fixed payments to lenders, and in the event of financial difficulties, it can more easily reduce or suspend its dividend payments. This approach can help to protect the company's financial stability in the long term.

Question 8

A firm's earnings per share is not impacted by its financing plan at the point when

Accepted Answer

At the point when the cost of borrowed funds equals the return on assets, the firm's earnings per share is not impacted by its financing plan as it is achieving an equilibrium in its return on investment (ROI) and cost of funds. This means that the firm is not over-leveraged or under-leveraged, therefore the financing plan does not have a significant impact on its earnings per share.

Question 9

Combined leverage is concerned with the relationship between

Accepted Answer

The answer of Combined leverage is concerned with the relationship...

Question 10

The degree of operating leverage is computed as

Accepted Answer

The degree of operating leverage (DOL) measures the responsiveness of operating income to changes in unit volume. It is calculated by dividing the percent change in operating income by the percent change in unit volume.

Question 11

Cash break-even analysis

Accepted Answer

Cash break-even analysis helps in analyzing the short-term outlook of a firm by determining the amount of sales required to cover all cash expenses, which is particularly helpful when the firm is facing financial difficulties.

Question 12

Firms with a high degree of operating leverage are

Accepted Answer

Firms with a high degree of operating leverage have high fixed costs, which means they have a lower per-unit variable cost. This can lead to higher profits if sales volumes are high. However, if sales volumes decrease, the high fixed costs can lead to significant losses. Thus, firms with a high degree of operating leverage are usually trading off higher fixed costs for lower per-unit variable costs.

Question 13

Firm A produces semiconductors using highly technical machinery; Firm B is a retail clothing store. Consider which firm employs a higher degree of operating leverage and then answer the following question: "Which of the following comparative statements about firms A and B is true?"

Accepted Answer

Firm A, with high fixed costs due to technical machinery, has higher operating leverage, leading to a higher break-even point but faster profit growth after breakeven compared to Firm B.

Question 14

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?

Accepted Answer

Firm A, with high operating leverage, has higher fixed costs leading to a higher break-even point. However, after breakeven, its profits grow faster due to lower variable costs per unit.

Question 15

Financial leverage deals with

Accepted Answer

Financial leverage deals with the relationship of debt and equity in the capital structure. It is the extent to which a company uses debt financing relative to equity financing.

Question 16

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?

Accepted Answer

The cash break-even point is calculated by excluding non-cash expenses like depreciation. The fixed costs excluding depreciation are $400,000 ($425,000 - $25,000). The contribution margin per unit is $60 ($120 - $60). Therefore, the cash break-even point is $400,000 / $60 = 6,667 units, which is less than 7,333 units.

Question 17

A high DOL means

Accepted Answer

A high Degree of Operating Leverage (DOL) indicates that a company has a high proportion of fixed costs relative to variable costs, meaning that changes in sales volume will have a more significant impact on operating income.

Question 18

If a firm has the lowest possible degree of operating leverage and the lowest possible degree of financial leverage, then

Accepted Answer

The lowest possible degree of operating leverage (DOL) is 1, indicating that operating income changes one-for-one with sales, showing no leverage effect. The lowest possible degree of financial leverage (DFL) is also 1, indicating that earnings per share (EPS) change one-for-one with operating income, again showing no leverage effect.

Question 19

If EBIT equals $200,000 and interest equals $40,000, what is the degree of financial leverage?

Accepted Answer

The answer of If EBIT equals $200,000 and interest equals...

Question 20

The degree of financial leverage is concerned with the relationship between

Accepted Answer

The degree of financial leverage measures the sensitivity of EPS to changes in EBIT. Therefore, it is concerned with the relationship between changes in EBIT and changes in EPS, making option C the best choice.

Quiz 5: Operating and Financial Leverage