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Exam 5: Operating and Financial Leverage

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Question 21

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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.

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Question 22

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Combined leverage is concerned with the relationship between

A) changes in EBIT and changes in EPS.
B) changes in volume and changes in EPS.
C) changes in volume and changes in EBIT.
D) changes in EBIT and changes in net income.

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Question 23

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If sales volume is less than the break-even point, the firm will experience

If a firm has a DFL of 2.0, EPS will change 2% for every 1% change in volume.

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.

The analysis of operating leverage assumes that relationships between revenues and costs are constant.

When a firm employs no debt

The degree of operating leverage is computed as

Leverage is the use of fixed costs to magnify returns at high levels of operation.

If a firm has a break-even point of 20,000 units and the contribution margin on the firm's single product is $3.00 per unit and fixed costs are $60,000, what will the firm's net income be at sales of 30,000 units?

Explain the implications of your answers if the machine shop business is highly cyclical.

If the contribution margin on the firm's single product is $2.00 per unit and fixed costs are $60,000, what will the firm's net income be at sales of 30,000 units?

If the price per unit increases but the cost structure remains the same

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

If the business cycle were just beginning its upswing, which firm would you anticipate would be likely to show the best growth in EPS over the next year? Firm A has high combined leverage and Firm B has low combined leverage.

The degree of financial leverage measures the percentage change in EPS for every 1 percent move in EBIT.

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

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

A firm would be indifferent between financing plans when

Doug Robinson is considering the possibility of opening his own manufacturing facility. He expects first-year sales to be $800,000, and he feels that his variable costs will be approximately 40% of sales. His fixed costs in the first year will be $200,000. Doug is considering two ways of financing the firm: (a) 40% equity financing and 60% debt at 10%, or (b) 100% equity financing. He can sell common stock to his relatives for $10 per share. Either way, he will need to raise $1,000,000. -Compute his break-even point in dollars.