Question 1

The higher financial leverage causes_________to increase more for a given increase in_________
A) EBIT, sales
B) EBIT, EPS
C) EPS, EBIT
D) EPS, sales

Accepted Answer

C

Question 2

The preferred approach to break-even analysis for the multiproduct firm is the
A) break-even point expressed in dollars.
B) overall break-even point.
C) cash break-even point.
D) break-even point expressed in units.

Accepted Answer

A

Question 3

The controversy over the existence of an optimal capital structure is debated between those_________who believe a traditional approach exists and those _________, who do not believe one exists. In the _________approach to capital structure, the optimal capital structure occurs where the_________is minimized.
A) traditionalists; supporters of Modigliani and Miller; traditional; cost of capital
B) traditionalists; supporters of Modigliani and Miller; traditional; degree of financial leverage
C) supporters of Modigliani and Miller; traditionalists; Modigliani and Miller; cost of capital
D) supporters of Modigliani and Miller; traditionalists; Modigliani and Miller; degree of financial leverage.

Accepted Answer

The traditionalists believe in an optimal capital structure that minimizes the cost of capital, while supporters of Modigliani and Miller argue that no optimal structure exists.

Question 4

Noncash charges such as depreciation and amortization_________the firm's break-even point. 
A) do not affect
B) decrease
C) overstate
D) understate

Accepted Answer

The answer of Noncash charges such as depreciation and amortization_________the...

Question 5

Fixed financial charges include
A) stock repurchase expense.
B) bond interest expense and preferred stock dividends.
C) common stock dividends and bond interest expense.
D) common stock dividends and preferred stock dividends.

Accepted Answer

Fixed financial charges refer to the regular payments a company has to make to its creditors and preferred stockholders. This includes bond interest expense and preferred stock dividends. Choice A is incorrect because stock repurchase expense is not a fixed financial charge. Choice C and D are incorrect because common stock dividends are not considered fixed financial charges.

Question 6

The cost of debt financing results from
A) the agency costs of the lender's monitoring and controlling the firm's actions.
B) the costs associated with managers having more information about the firm's prospects than do investors.
C) the increased profitability of bankruptcy caused by debt obligations.
D) all of the above.

Accepted Answer

The cost of debt financing includes agency costs related to monitoring, information asymmetry between managers and investors, and the risk of bankruptcy due to debt obligations.

Question 7

_________is the potential use of fixed operating costs to magnify the effects of changes in sales on earnings before interest and taxes.
A) Financial leverage
B) Total leverage
C) Operating leverage
D) Ratio analysis

Accepted Answer

Operating leverage is the degree to which fixed costs are used in a company's operations. It can be measured by the ratio of EBIT (earnings before interest and taxes) to operating income. Therefore, EBIT is directly related to operating leverage. Financial leverage refers to the use of debt to finance a company's operations, while total leverage takes into consideration both operating and financial leverage. Ratio analysis involves the use of various financial ratios to evaluate a company's performance.

Question 8

In 1999, the overall debt ratio for all Canadian industries is_________percent which is the result of_________companies being included.
A) 74.9%; manufacturing
B) 12.1%; wholesaling
C) 74.9%; financial
D) 12.1%; retailing

Accepted Answer

The question states that the overall debt ratio for all Canadian industries is due to companies being included, implying that the answer choice should specify which industry. Option C includes the word "financial," which indicates that it is specifically referring to the financial industry's debt ratio. The other options mention wholesaling, manufacturing, and retailing, but do not specify a particular industry's debt ratio.

Question 9

In theory, the firm should maintain financial leverage consistent with a capital structure that
A) maximizes the earnings per share.
B) meets the industry standard.
C) maximizes dividends.
D) maximizes the owner's wealth.

Accepted Answer

The primary goal of the firm should be to maximize the wealth of the owners, and financial leverage should be maintained in a way that is consistent with this goal. Maximizing earnings per share or dividends may not always align with the long-term interests of the firm or its shareholders. Meeting the industry standard is also not necessarily an optimal strategy, as each firm's capital needs and risk profile may differ.

Question 10

M and M Proposition II states that
A) the value of a firm's assets and operations does not change with changes in the firm's capital structure.
B) the value of the firm is maximized when the WACC after-tax is minimized.
C) the cost of equity is a positive linear function of its capital structure.
D) the only risk relevant in measuring the cost of equity is business risk.

Accepted Answer

M and M Proposition II states that the cost of equity increases linearly with the firm's debt-to-equity ratio, reflecting the increased financial risk from higher leverage.

Question 11

The major shortcoming of the EBIT-EPS approach to capital structure is that
A) the technique does not consider the cost of capital.
B) the technique does not promote the maximization of shareholder wealth.
C) the technique only considers leverage-related risk.
D) the technique does not maximize earnings per share.

Accepted Answer

The EBIT-EPS approach focuses on maximizing earnings per share, but it does not necessarily align with the goal of maximizing shareholder wealth, which considers the cost of capital and overall firm value.

Question 12

With the existence of fixed operating costs, an increase in sales will result in___________increase inEBIT.
A) a proportional
B) a more than proportional
C) a less than proportional
D) an equal

Accepted Answer

With fixed operating costs, an increase in sales leads to a more than proportional increase in EBIT because the fixed costs are spread over a larger sales volume, reducing the per-unit cost and increasing profitability.

Question 13

At the operating break-even point,_________equals zero. 
A) sales revenue
B) earnings before interest and taxes
C) variable operating costs
D) fixed operating costs

Accepted Answer

At the operating break-even point, earnings before interest and taxes (EBIT) equals zero because this is the point where total revenues equal total operating costs (both fixed and variable), resulting in no profit or loss.

Question 14

M and M Proposition I states that
A) the value of a firm's assets and operations does not change with changes in the firm's capital structure.
B) the value of the firm is maximized when the WACC after-tax is minimized.
C) the cost of equity is a positive linear function of its capital structure.
D) the only risk relevant in measuring the cost of equity is business risk.

Accepted Answer

M and M Proposition I states that the value of a firm's assets and operations does not change with changes in the firm's capital structure. This means that the market value of the firm remains the same, regardless of whether it is financed by debt or equity. Therefore, choice A is the correct answer.

Question 15

A firm has a current capital structure consisting of $400,000 of 12 percent annual interest debt and50,000 shares of common stock. The firm's tax rate is 40 percent on ordinary income. If the EBIT isexpected to be $200,000, two EBIT-EPS coordinates for the firm's existing capital structure are
A) ($0, $48,000) and ($200,000, $1.82)
B) ($152,000, $3.50) and ($150,000, $1.82)
C) ($36,000, $0) and ($200,000, $3.04)
D) ($48,000, $0) and ($200,000, $1.82)

Accepted Answer

The interest on debt is $48,000 (12% of $400,000). At EBIT of $48,000, EPS is $0 because all earnings go to interest. At EBIT of $200,000, after interest and taxes, EPS is $1.82.

Question 16

An increase in fixed operating costs will result in_________in the degree of operating leverage. 
A) an undetermined change
B) a decrease
C) an increase
D) no change

Accepted Answer

An increase in fixed operating costs means that the company has to spend more money on those fixed costs regardless of their level of production or sales. This means that the company will have to sell more units or generate more revenue just to break even. Therefore, an increase in fixed operating costs will result in an increase in the breakeven point, leading to higher sales volume needed to earn a profit.

Question 17

A corporation borrows $1,000,000 at 10 percent annual rate of interest. The firm has a 40 percent taxrate. The yearly, aftertax cost of this debt is ___________ .
A) $166,667
B) $100,000
C) $40,000
D) $60,000

Accepted Answer

First, we need to calculate the annual interest expense, which is:
$1,000,000 x 10% = $100,000

Next, we need to calculate the tax savings from the interest expense, which is:
$100,000 x 40% = $40,000

Finally, we subtract the tax savings from the interest expense to get the aftertax cost of debt:
$100,000 - $40,000 = $60,000

Therefore, the answer is D ($60,000).

Question 18

Using debt to raise capital is frequently viewed as a___________signal by the financial community. 
A) negative
B) weak
C) neutral
D) positive

Accepted Answer

Using debt to raise capital can be seen as positive because it allows a company to leverage its existing assets and generate additional revenue without diluting the ownership stake of existing shareholders. Debt may also be tax-deductible, which can result in cost savings for the company. However, it is important to manage debt levels carefully to avoid defaulting on payments and damaging the company's creditworthiness.

Question 19

With the existence of fixed operating costs, a decrease in sales will result in_________in EBIT. 
A) a less than proportional decrease
B) an equal increase
C) a more than proportional decrease
D) a proportional increase

Accepted Answer

Fixed operating costs stay the same regardless of changes in sales. Therefore, when sales decrease, the total costs will be spread over fewer units, resulting in a more than proportional decrease in profits. This is known as operating leverage.

Question 20

_________leverage is concerned with the relationship between earnings before interest and taxes and earnings per share.
A) Variable
B) Financial
C) Total
D) Operating

Accepted Answer

Leverage is a financial concept that relates to the use of debt to finance a business or investment. It is concerned with the impact that changes in the company's earnings before interest and taxes (EBIT) have on its earnings per share (EPS). Therefore, leverage is considered a financial ratio that measures the company's ability to use debt financing to increase its profits.

Quiz 10: Leverage and Capital Structure

The higher financial leverage causes_to increase more for a given increase in_

The preferred approach to break-even analysis for the multiproduct firm is the

The controversy over the existence of an optimal capital structure is debated between those_____who believe a traditional approach exists and those _, who do not believe one exists. In the _approach to capital structure, the optimal capital structure occurs where the_____is minimized.

Noncash charges such as depreciation and amortization_________the firm's break-even point.

Fixed financial charges include

The cost of debt financing results from

_________is the potential use of fixed operating costs to magnify the effects of changes in sales on earnings before interest and taxes.

In 1999, the overall debt ratio for all Canadian industries is_percent which is the result of_companies being included.

In theory, the firm should maintain financial leverage consistent with a capital structure that

M and M Proposition II states that

The major shortcoming of the EBIT-EPS approach to capital structure is that

With the existence of fixed operating costs, an increase in sales will result in___________increase inEBIT.

At the operating break-even point,_________equals zero.

M and M Proposition I states that

A firm has a current capital structure consisting of $400,000 of 12 percent annual interest debt and50,000 shares of common stock. The firm's tax rate is 40 percent on ordinary income. If the EBIT isexpected to be $200,000, two EBIT-EPS coordinates for the firm's existing capital structure are

An increase in fixed operating costs will result in_________in the degree of operating leverage.

A corporation borrows $1,000,000 at 10 percent annual rate of interest. The firm has a 40 percent taxrate. The yearly, aftertax cost of this debt is ___________ .

Using debt to raise capital is frequently viewed as a___________signal by the financial community.

With the existence of fixed operating costs, a decrease in sales will result in_________in EBIT.

_________leverage is concerned with the relationship between earnings before interest and taxes and earnings per share.