Deck 12: Leverage and Capital Structure

Question 1

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.

Answer 1

True

Question 2

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.

Answer 2

True

Question 3

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

Answer 3

False

Question 4

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

Question 5

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

Question 6

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

Question 7

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

Question 8

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

Question 9

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

Question 10

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

Question 11

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

Question 12

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

Question 13

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 14

The amount of leverage in the 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 15

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 16

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 17

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

Question 18

Sales commission may be considered as a semivariable cost because it may be fixed for a certain volume of sales and then increase to higher levels for higher volumes.

Question 19

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

Question 20

Firm's capital structure is the mix of the short-term debt, long-term debt, and equity maintained by the firm.

Question 21

________ 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 22

A firm's operating breakeven point is sensitive to all of the following variables EXCEPT

A) fixed operating costs.
B) sales price per unit.
C) interest expense.
D) variable operating cost per unit.

Question 23

Breakeven analysis is used by the firm

A) to determine the level of operations necessary to cover all operating costs.
B) to evaluate the profitability associated with various levels of sales.
C) Both A and B
D) none of the above

Question 24

________ costs are a function of volume, not time.

A) Fixed operating
B) Semi-variable
C) Variable
D) Fixed financial

Question 25

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 26

The cash breakeven point is used when certain noncash charges, such as depreciation, constitute an important portion of the firm's fixed operating costs.

Question 27

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

Question 28

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

Question 29

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

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

Question 30

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 31

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 32

If a firm's sale price per unit decreases, the firm's operating breakeven point will

A) decrease.
B) increase.
C) remain unchanged.
D) change in an undetermined direction.

Question 33

The firm's ________ is the level of sales necessary to cover all operating costs, i.e., the point at which EBIT = $0.

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

Question 34

Which of the following is NOT a variable cost?

A) Materials used.
B) Rent.
C) Delivery costs.
D) Direct labor.

Question 35

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

Question 36

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

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

Question 37

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

Question 38

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

A) decrease.
B) increase.
C) remain unchanged.
D) change in an undetermined direction.

Question 39

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

Question 40

If a firm's variable costs per unit increase, the firm's operating breakeven point will

A) decrease.
B) increase.
C) remain unchanged.
D) change in an undetermined direction.

Question 41

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 1000 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) There is not enough information given in the problem to make the decision.

Question 42

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

Question 43

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 44

The per dollar contribution toward fixed operating costs and profits provided by each dollar of sales is the

A) profit margin.
B) contribution margin.
C) expense ratio.
D) fixed coverage ratio.

Question 45

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

Question 46

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 the firm's earnings per share.

Question 47

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) none of the above.

Question 48

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 49

One function of breakeven analysis is to

A) create profits.
B) describe leverage.
C) evaluate the profitability of various sales levels.
D) determine the amount of financing needed by the firm.

Question 50

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

A) decrease.
B) increase.
C) remain unchanged.
D) change in an undetermined direction.

Question 51

The 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 52

The preferred approach to breakeven analysis for the 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 53

Noncash charges such as depreciation and amortization ________ the firm's breakeven point.

A) do not affect
B) overstate
C) understate
D) decrease

Question 54

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) none of the above.

Question 55

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 56

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) 250; $ 6,250
B) 400; $10,000
C) 667; $16,675
D) 1,000; $25,000

Question 57

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

Question 58

Which one of the following is considered a limitation of breakeven analysis?

A) It assumes that the firm faces linear, or nonvarying, sales revenue and total operating cost functions.
B) It is difficult to break semivariable costs into fixed and variable components.
C) It has a short-term time horizon.
D) All of the above.

Question 59

A firm has fixed operating costs of $525,000, of which $125,000 is depreciation expense. The firm's sales price per unit is $35 and its variable cost per unit is $22.50. The firm's cash operating breakeven point in units is

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

Question 60

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 desires net operating income of $10,000, not $0 (zero)?

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

Question 61

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

Question 62

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

Question 63

Holding all other factors constant, a firm that is subject to a greater level of business risk should employ more total leverage than an otherwise equivalent firm that is subject to a lesser level of business risk.

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

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

Question 66

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

Question 67

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 68

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 69

In general, the greater the firm's operating leverage, the higher its business risk.

Question 70

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

Question 71

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 72

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 the firm's earnings per share (EPS).

Question 73

The long-term funds of the firm are called

A) debt.
B) assets.
C) capital.
D) equity.

Question 74

The effect of financial leverage is such that an increase in the 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 75

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

Question 76

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 77

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

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

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.

Question 80

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.