Question 1

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

Accepted Answer

Contribution margin represents the amount of sales left over after variable costs are paid, not fixed costs.

Question 2

Contribution margin is equal to fixed costs minus variable costs.

Accepted Answer

Contribution margin is equal to sales minus variable costs, not fixed costs.

Question 3

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

Accepted Answer

Variable cost changes with the level of production or sales, while fixed cost remains constant regardless of the level of production or sales.

Question 4

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

Accepted Answer

Financial leverage refers to the use of debt in the business to increase profitability and return on investment. It highlights how the use of debt can amplify the gains or losses made by a company.

Question 5

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

Accepted Answer

Operating leverage measures how much a firm relies on fixed costs versus variable costs in its operations. Therefore, altering the mix of fixed capital resources and variable labor will directly affect the firm's operating leverage. Increasing fixed costs (e.g. investing in more machinery) while keeping variable costs (e.g. labor) constant will increase operating leverage, while decreasing fixed costs and increasing variable costs will decrease operating leverage.

Question 6

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

Accepted Answer

To determine the break-even point for a company, you divide the fixed costs by the contribution margin per unit or contribution margin ratio, not the other way around.

Question 7

Property taxes and depreciation expense are examples of variable costs.

Accepted Answer

Property taxes and depreciation expense are examples of fixed costs, as they generally do not vary with changes in production or sales levels.

Question 8

Sales commissions and raw materials are variable costs.

Accepted Answer

Sales commissions and raw materials costs vary in proportion to the level of sales or production. Therefore, they are considered variable costs.

Question 9

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

Accepted Answer

Operating leverage refers to the degree to which fixed costs are used in a company's operations. It does not determine how income from operations is to be divided between debt holders and stockholders. That is determined by the company's capital structure and dividend policy.

Question 10

Operating leverage works best when product volume is increasing.

Accepted Answer

Operating leverage measures the proportion of fixed costs in a company's cost structure. When the volume of product increases, the fixed costs are spread over a higher number of units, resulting in higher margins and profits. Therefore, 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.

Accepted Answer

A lower sales price reduces the per-unit revenue, which means the firm must sell more units to cover its fixed and variable costs, thus increasing the 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.

Accepted Answer

Break-even analysis involves calculating the point at which a company's total revenue equals its total costs, resulting in zero profit. This is usually expressed in terms of the quantity of units or products that need to be sold.

Question 13

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

Accepted Answer

The contribution margin is equal to sales price per unit minus variable costs per unit, not total costs per unit. Total costs include both variable and fixed costs.

Question 14

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

Accepted Answer

The use of financial leverage involves borrowing funds to invest in assets with the aim of increasing returns. However, this strategy also involves increased risk as the borrowed funds must be repaid regardless of the returns earned. Therefore, 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.

Accepted Answer

Operating leverage refers to the extent to which fixed costs are used in a company's operations. When a company has high operating leverage, small changes in sales or revenues can result in larger changes in profits or earnings per share (EPS). This is because a higher proportion of the costs required to generate those sales or revenues are fixed and do not change with changes in output or activity levels. Therefore, if a company can increase its sales or revenue, it will experience a larger increase in profits or EPS due to the magnification effect of fixed costs.

Question 16

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

Accepted Answer

The break-even point is the point at which a company's total revenue equals its total costs, resulting in zero profit or loss. The contribution margin is the amount of revenue left over after deducting variable costs from sales revenue. As the contribution margin increases, more revenue is available to cover the fixed costs, which in turn, lowers the break-even point. Therefore, the statement is true.

Question 17

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

Accepted Answer

If economic conditions were expected to be favorable, investors may be more willing to take on risk and therefore may prefer firms with a higher degree of leverage. This is because a highly leveraged firm may be able to generate higher returns in a favorable economic environment, but also poses more risk in an unfavorable economic environment.

Question 18

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

Accepted Answer

Operating leverage is the degree to which fixed costs are used in a business. It measures the impact of using fixed assets, such as buildings, machinery, and equipment, on the profitability of a company.

Question 19

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

Accepted Answer

Operating leverage refers to the degree to which a company uses fixed costs in its operations. By committing to heavy fixed costs in the manufacturing process, a business increases its operating leverage, which can have both positive and negative effects on profitability.

Question 20

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

Accepted Answer

Financial leverage refers to the use of debt to finance a company's operations or growth. Therefore, when a business decides to use debt in financing their firm, they are indeed engaging in financial leverage.

Quiz 5: Operating and Financial Leverage