Question 1

The degree of financial leverage is defined as the percentage change in
A)EBIT resulting from a given percentage change in sales
B)EPS resulting from a given percentage changes in sales
C)EBIT resulting from a given percentage change in EPS
D)EPS resulting from a given percentage change in EBIT

Accepted Answer

The degree of financial leverage measures the sensitivity of EPS to changes in EBIT. It is calculated as the percentage change in EPS resulting from a given percentage change in EBIT. Therefore, option D is the correct choice.

Question 2

Cash insolvency analysis evaluates the adequacy of a firm's cash position in a
A)bankruptcy proceeding
B)non-normal environment
C)highly competitive environment
D)recessionary environment

Accepted Answer

D

Question 3

When fixed operating costs are incurred by the firm, a change in is magnified into a relatively larger change in earnings before interest and taxes.
A)overhead expenses
B)interest charges
C)labor costs
D)sales revenue

Accepted Answer

Fixed operating costs, such as rent and salaries, stay the same regardless of the level of sales revenue. Therefore, any change in sales revenue directly affects earnings before interest and taxes (EBIT). If sales revenue increases, EBIT will increase by a greater percentage due to the fixed cost structure, resulting in higher profits. Conversely, if sales revenue decreases, EBIT will decrease by a greater percentage, leading to potential losses.

Question 4

In the analysis of financial leverage, all of the following are referred to as fixed charges except:
A)bond interest
B)common stock dividends
C)bank interest
D)preferred stock dividends

Accepted Answer

Fixed charges refer to expenses that must be paid regardless of a company's level of sales or earnings. These include things like interest on loans and bonds, but do not include common stock dividends, which are only paid out of profits and are not an obligation of the company. Bank interest and preferred stock dividends are also considered fixed charges.

Question 5

Rent, insurance, and the salaries of top management are examples of:
A)fixed costs
B)capital costs
C)variable costs
D)fluctuating costs

Accepted Answer

Fixed costs are expenses that do not vary with an increase or decrease in the production level of goods or services. Rent, insurance and salaries of top management remain constant regardless of the amount of goods or services produced. Therefore, they are considered fixed costs.

Question 6

An analytical technique called can be used to help determine when debt financing is advantageous and when equity financing is advantageous.
A)DFL-EPS analysis
B)EBIT-EPS analysis
C)DCL-EPS analysis
D)DOL-EBIT analysis

Accepted Answer

The EBIT-EPS analysis (Earnings Before Interest and Taxes - Earnings Per Share) helps determine the level of EBIT required to maintain a certain EPS when financing is done through either debt or equity. This analysis can help determine when debt financing is advantageous (when the cost of debt is lower than the required EBIT to maintain EPS) and when equity financing is advantageous (when the cost of equity is lower than the required EBIT to maintain EPS). Therefore, B is the best choice.

Question 7

The degree of combined leverage is defined as the percentage change in earnings per share resulting from a given percentage change in
A)operating costs
B)interest charges
C)common stock dividends
D)sales (or output)

Accepted Answer

The degree of combined leverage is a measure of the company's sensitivity to changes in sales (or output), which ultimately drives changes in earnings per share. Therefore, a given percentage change in sales will result in a certain percentage change in earnings per share, which is determined by the degree of combined leverage. Changes in operating costs, interest charges, or common stock dividends may affect earnings, but they do not directly determine the degree of combined leverage.

Question 8

Financial leverage causes a firm's to change at a rate greater than the change in .
A)EBIT;EPS
B)EPS;EBIT
C)EBIT;sales
D)sales;EBIT

Accepted Answer

Financial leverage is the use of debt to finance a portion of a company's assets. By doing so, a company can increase the potential return on equity, but it also increases the potential risk of bankruptcy. Financial leverage increases the variability of earnings available for common shareholders, known as earnings per share (EPS), by magnifying the effect of changes in earnings before interest and taxes (EBIT). As a result, a firm's EPS changes at a rate greater than the change in EBIT due to financial leverage.

Question 9

The degree of combined leverage is equal to the multiplied by the .
A)degree of operating leverage, variable cost ratio
B)degree of financial leverage, variable cost ratio
C)degree of operating leverage, degree of financial leverage
D)degree of operating leverage, fixed cost ratio

Accepted Answer

The degree of combined leverage is calculated by multiplying the degree of operating leverage (which measures the effect of fixed operating costs on earnings) by the degree of financial leverage (which measures the effect of fixed financial costs on earnings).

Question 10

Raw material and direct labor costs are examples of
A)fixed costs
B)overhead costs
C)variable costs
D)capital costs

Accepted Answer

Raw material and direct labor costs are both directly variable with changes in production.

Question 11

The percentage change in a firm's EBIT that results in a 1% change in sales or output is known as the
A)degree of combined leverage
B)degree of financial leverage
C)degree of operating leverage
D)degree of business risk

Accepted Answer

The percentage change in a firm's EBIT that results from a change in sales or output is known as the degree of operating leverage. It helps measure the sensitivity of a company's EBIT to changes in sales or output.

Question 12

A firm that employs relatively large amounts of labor- saving equipment in its operations will have a relatively degree of operating leverage.
A)low
B)constant
C)insignificant
D)high

Accepted Answer

A firm with a high degree of operating leverage typically relies heavily on fixed costs, such as equipment and machinery, in its operations. As a result, small changes in revenue can have a large impact on the firm's profitability. Therefore, a firm that employs relatively large amounts of labor-saving equipment in its operations will have a high degree of operating leverage.

Question 13

A firm that employs a relatively large proportion of debt and preferred stock in its capital structure will have a relatively degree of financial leverage.
A)low
B)high
C)insignificant
D)constant

Accepted Answer

A firm with a higher proportion of debt and preferred stock in its capital structure is considered to have a higher degree of financial leverage. This is because debt and preferred stock are fixed-cost sources of financing that require regular interest or dividend payments, which can magnify the impact of changes in a company's earnings. Thus, a high degree of financial leverage can amplify both gains and losses in a company's earnings and also increase the overall risk to shareholders.

Question 14

A firm which has a 2.5 DOL (degree of operating leverage) would find that an 8% increase in EBIT would result from a increase in sales.
A)3.2%
B)5.4%
C)20.0%
D)2.0%

Accepted Answer

The degree of operating leverage (DOL) is a measure of how much a firm's operating income (EBIT) will change in response to a change in sales. The DOL is calculated as follows:DOL = % Change in EBIT / % Change in SalesIn this case, the firm has a DOL of 2.5, which means that a 1% increase in sales will result in a 2.5% increase in EBIT. Therefore, an 8% increase in sales will result in a 20% increase in EBIT.

Question 15

In EBIT-EPS analysis, the indifference point is found at the point where for the two alternative financing plans are equal.
A)EBIT
B)EPS
C)stock prices
D)DOL

Accepted Answer

The indifference point in EBIT-EPS analysis is where the Earnings Per Share (EPS) for two different financing plans are equal, indicating no advantage of one plan over the other at that level of EBIT.

Question 16

To balance the operating and financial risks that are so variable for a multinational company, Nestle allows its foreign operating subsidiaries operational flexibility and follows a financing strategy.
A)decentralized, centralized
B)centralized, centralized
C)centralized, decentralized
D)decentralized, decentralized

Accepted Answer

Nestle allows its foreign operating subsidiaries to have operational flexibility, indicating a decentralized approach. However, to balance the risks, it follows a financing strategy, indicating a centralized approach. Therefore, the best choice is A) decentralized, centralized.

Question 17

The degree of combined leverage is equal to the degree of operating leverage the degree of financial leverage.
A)added to
B)divided by
C)multiplied by
D)subtracted from

Accepted Answer

The degree of combined leverage is the product of the degree of operating leverage and the degree of financial leverage. This means that one is multiplied by the other, making choice C the correct answer.

Question 18

The total variability of the firm's EPS associated with a change in sales is an indication of combined leverage and is best measured by
A)DOL
B)DFL
C)DOL + DFL
D)DOL × DFL

Accepted Answer

The question specifically asks for a measurement of the total variability of EPS associated with a change in sales, which is a combination of both operating leverage (measured by DOL) and financial leverage (measured by DFL). Therefore, the correct answer is the product of DOL and DFL, which is D.

Question 19

When fixed capital costs are incurred by the firm, a change in is magnified into a larger change in earnings per share.
A)earnings before interest and taxes
B)overhead expenses
C)interest charges
D)preferred dividends

Accepted Answer

Fixed capital costs are a long-term investment, and therefore represent a higher portion of a company's total assets. As a result, a change in earnings before interest and taxes (EBIT) will be magnified into a larger change in earnings per share. This is because any changes to EBIT will have a significant impact on the company's overall profitability, which in turn affects the value of its shares.

Question 20

A firm is considering the purchase of assets that will increase its fixed operating costs.The firm should decrease the proportion of it employs in its capital structure if it wants to maintain its existing degree of combined leverage.
A)debt
B)warrants
C)common stock
D)common stock and warrants

Accepted Answer

If the firm wants to maintain its existing degree of combined leverage, which is the proportion of fixed costs to total costs, it must decrease the proportion of equity in its capital structure. This can be achieved by increasing the proportion of debt, which has a fixed cost of interest payments, and decreasing the proportion of common stock or warrants, which have variable costs in the form of dividends or dilution of ownership. Therefore, choice A) debt is the best option.

Quiz 14: Capital Structure Management in Practice

The degree of financial leverage is defined as the percentage change in

Cash insolvency analysis evaluates the adequacy of a firm's cash position in a

When fixed operating costs are incurred by the firm, a change in is magnified into a relatively larger change in earnings before interest and taxes.

In the analysis of financial leverage, all of the following are referred to as fixed charges except:

Rent, insurance, and the salaries of top management are examples of:

An analytical technique called can be used to help determine when debt financing is advantageous and when equity financing is advantageous.

The degree of combined leverage is defined as the percentage change in earnings per share resulting from a given percentage change in

Financial leverage causes a firm's to change at a rate greater than the change in .

The degree of combined leverage is equal to the multiplied by the .

Raw material and direct labor costs are examples of

The percentage change in a firm's EBIT that results in a 1% change in sales or output is known as the

A firm that employs relatively large amounts of labor- saving equipment in its operations will have a relatively degree of operating leverage.

A firm that employs a relatively large proportion of debt and preferred stock in its capital structure will have a relatively degree of financial leverage.

A firm which has a 2.5 DOL (degree of operating leverage) would find that an 8% increase in EBIT would result from a increase in sales.

In EBIT-EPS analysis, the indifference point is found at the point where for the two alternative financing plans are equal.

To balance the operating and financial risks that are so variable for a multinational company, Nestle allows its foreign operating subsidiaries operational flexibility and follows a financing strategy.

The degree of combined leverage is equal to the degree of operating leverage the degree of financial leverage.

The total variability of the firm's EPS associated with a change in sales is an indication of combined leverage and is best measured by

When fixed capital costs are incurred by the firm, a change in is magnified into a larger change in earnings per share.

A firm is considering the purchase of assets that will increase its fixed operating costs.The firm should decrease the proportion of it employs in its capital structure if it wants to maintain its existing degree of combined leverage.