Question 1

Breakeven analysis can be used to determine how large sales of a new product must be for the firm to achieve profitability,but it is not useful in studying the effects of a general expansion in the firm's operations.

Accepted Answer

Breakeven analysis can be useful in studying the effects of a general expansion in the firm's operations as it can help determine the minimum level of sales needed to cover the increased costs of the expansion and achieve profitability.

Question 2

The purpose of financial breakeven analysis is to determine the level of sales a firm needs in order to cover the fixed and variable costs associated with producing and selling inventory items.

Accepted Answer

Financial breakeven analysis specifically determines the level of sales needed to cover all fixed costs, resulting in a net income of zero. It does not typically account for variable costs in the calculation, which are instead considered in the calculation of the contribution margin.

Question 3

The degree of financial leverage gives an indication of how a change in EBIT will affect EPS.

Accepted Answer

The degree of financial leverage (DFL) measures the sensitivity of earnings per share (EPS) to changes in earnings before interest and taxes (EBIT). Therefore, a higher DFL indicates that a small change in EBIT can result in a larger change in EPS, making EPS more volatile.

Question 4

Everything else equal,the higher the DFL is for a firm,the closer its operations are to its financial breakeven point.

Accepted Answer

Debt financing increases a firm's fixed costs in the form of interest payments, which raises the financial breakeven point. Therefore, a higher degree of financial leverage (DFL) implies that a larger proportion of a firm's operating income is required to cover its financial costs, thus indicating a closer proximity to the financial breakeven point.

Question 5

The closer a firm is to its operating breakeven point,the greater is the absolute value of the degree of operating leverage.

Accepted Answer

The degree of operating leverage measures the responsiveness of a firm's operating income to changes in its sales. It is calculated as the percentage change in operating income resulting from a 1% change in sales. The formula for the degree of operating leverage is:

Degree of Operating Leverage = % Change in Operating Income / % Change in Sales

When a firm is closer to its operating breakeven point (i.e. the point where its revenues equal its total costs), it means that it has a smaller margin of safety and is more sensitive to changes in sales. As a result, any increase or decrease in sales will have a larger impact on operating income, causing the degree of operating leverage to increase. Therefore, the statement is true.

Question 6

If a firm has no preferred stock,its financial breakeven point is the sales level that results in net income equal to zero.

Accepted Answer

This statement is true. The financial breakeven point refers to the sales level at which a company’s net income is zero, meaning it has covered all of its fixed and variable costs but has not yet generated any profit above those costs. Since preferred stock is not considered in calculating the financial breakeven point, the absence of preferred stock would not have any impact on the calculation.

Question 7

The higher the percentage of a firm's total costs that are fixed,the higher the degree of operating leverage and the lower the operating breakeven point.

Accepted Answer

A higher percentage of fixed costs increases the degree of operating leverage, but it raises the operating breakeven point because more revenue is needed to cover the fixed costs before the company can start making a profit.

Question 8

The DOL is an index number that measures the effect of a change in sales price on the operating breakeven point.

Accepted Answer

The Degree of Operating Leverage (DOL) measures the effect of a change in sales volume on operating income, not the effect of a change in sales price on the operating breakeven point.

Question 9

Other things held constant,if a firm is operating at a profit and then sales increase,the degree of operating leverage will decline.

Accepted Answer

When a firm is operating at a profit and experiences an increase in sales, its fixed costs are spread over a larger number of units, reducing the proportion of fixed costs per unit. This decreases the firm's degree of operating leverage, as the firm becomes less sensitive to changes in sales volume.

Question 10

Operating costs include variable costs,depreciation,and interest charges.

Accepted Answer

Operating costs include variable costs and depreciation but not interest charges. Interest charges are considered non-operating expenses and are not included in operating costs.

Question 11

Alternative methods for producing a given product often have different degrees of operating leverage and hence have different breakeven points and degrees of risk.

Accepted Answer

Alternative methods for producing a product may have different degrees of operating leverage, which affects the breakeven point and degree of risk associated with each method.

Question 12

Everything else equal,the higher the DFL is for a firm,the closer its operations are to its operating breakeven point.

Accepted Answer

DFL (Degree of Financial Leverage) measures the sensitivity of a firm's earnings per share to fluctuations in its operating income, indicating the impact of financial leverage, not how close a firm is to its operating breakeven point.

Question 13

As a firm's sales grow its current asset accounts tend to increase.For instance,as sales increase the firm's purchases increase and its level of accounts payable will increase.Thus,spontaneously generated funds will arise from transaction accounts that increase as sales increase.

Accepted Answer

This statement is true as an increase in sales generally leads to an increase in current assets such as accounts receivable and inventory, as well as an increase in accounts payable as the firm purchases more goods and services to support the higher level of sales activity. These changes in current assets and liabilities can generate additional funds for the firm.

Question 14

Today,computer simulation models can calculate multiple breakeven charts providing management with an idea of how the firm's breakeven point would change under different assumptions for key variables.

Accepted Answer

Computer simulation models can indeed calculate multiple breakeven charts with different assumptions for key variables.

Question 15

Two key objectives of financial planning and control are to avoid cash squeezes and to improve profitability.

Accepted Answer

Financial planning and control aims to ensure that a company has enough cash to meet its financial obligations while also maximizing profits. By avoiding cash squeezes, a company can avoid defaulting on loans or payments, while improving profitability can lead to increased revenue and stronger financial performance overall.

Question 16

The term "spontaneously generated funds" generally refers to increases in the cash account that result from growth in sales,assuming the firm is operating with a positive profit margin.

Accepted Answer

The answer of The term "spontaneously generated funds" generally refers...

Question 17

Errors in the sales forecast can be offset by similar errors in costs and income forecasts.Thus,as long as the errors are not large,sales forecast accuracy is not critical to the firm.

Accepted Answer

Errors in sales forecast can have ripple effects on other parts of the business, such as inventory, production, and marketing. Inaccurate forecasts can result in overproduction or underproduction, missed sales opportunities, and increased operational costs. Therefore, sales forecast accuracy is critical to the firm.

Question 18

To determine the amount of additional funds needed,you may subtract the expected increase in liabilities (a source of funds)from the sum of the expected increases in retained earnings and assets (both uses of funds).

Accepted Answer

To determine the amount of additional funds needed, you would subtract the expected increase in assets and retained earnings (sources of funds) from the expected increase in liabilities (uses of funds).

Question 19

One limitation of operating breakeven analysis is that variable cost must be assumed constant throughout the analysis in order to completely analyze changes in fixed investment.

Accepted Answer

The answer of One limitation of operating breakeven analysis is...

Question 20

Two firms which have the same operating leverage must also have the same ROA,since operating leverage and ROA both measure the effective utilization of assets by the firm.

Accepted Answer

Operating leverage measures the degree to which a company's income is affected by changes in revenue, while ROA measures how efficiently a company is using its assets to generate profits. While these two metrics may be related, they are not the same and do not have to be identical between two firms with the same operating leverage.

Quiz 17: Financial Planning and Control