CH 5 POF: Finance Test Flashcards
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"Operating leverage" is the use of fixed costs to magnify returns at high levels of operation. True False
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t
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Operating leverage works best when volume is increasing. True False
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t
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Operating leverage emphasizes the impact of using fixed assets in the business. True False
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t
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Financial leverage emphasizes the impact of using debt in the business. True False
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t
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Operating leverage determines how income from operations is to be divided between debt holders and stockholders. True False
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f
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Operating leverage will change when a firm alters the mix of fixed capital resources and variable labor that it uses. True False
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t
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Contribution margin is equal to fixed costs minus variable costs. True False
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f
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Property taxes and depreciation expense are examples of variable costs. True False
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f
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Sales commissions and raw materials are variable costs. True False
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t
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The contribution margin is equal to sales price per unit minus total costs per unit. True False
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f
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As the contribution margin rises, the break-even point goes down. True False
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t
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A lower price for the firm's product will reduce the firm's break-even point. True False
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f
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If economic conditions were expected to be favorable, an investor would likely prefer a firm with a low degree of leverage. True False
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f
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Use of financial leverage must consider risk, not just maximizing profit. True False
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t
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For firms in industries that offer some degree of stability, are in a positive stage of growth, and are operating in favorable economic conditions, the use of debt is not needed or recommended. True False
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f
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Managers who are risk-averse and uncertain about the future would most likely minimize combined leverage. True False
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t
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Management should tailor the use of leverage to meet its own risk-taking desires. True False
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t
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Cash break-even analysis eliminates the depreciation expense and other non-cash charges from fixed costs. True False
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t
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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. True False
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f
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The closer a firm is to its break-even point, the lower the degree of operating leverage it will be. True False
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f
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Degree of operating leverage should be computed only over a profitable range of operations. True False
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t
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Linear break-even analysis assumes that costs are linear functions of volume. True False
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t
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Linear break-even analysis and operating leverage are only valid within a relevant range of production. True False
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t
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Financial leverage primarily affects the left-hand side of the balance sheet. True False
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f
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Operating leverage primarily affects the left-hand side of the balance sheet, while financial leverage affects the right-hand side of the balance sheet. True False
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t
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The degree of financial leverage measures the percentage change in EPS for every 1% move in EBIT. True False
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t
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If a firm has a DFL of 2.0, EPS will change 2% for every 1% change in volume. True False
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f
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The degree of financial leverage is not influenced by the interest rate on debt, only the amount borrowed. True False
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f
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A firm with a high degree of financial leverage could face financial difficulty even though it is in a stable industry. True False
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t
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Operating income is not the same thing as EBIT. True False
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f
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Operating leverage influences the bottom half of the income statement while financial leverage deals with the top half. True False
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f
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The degree of combined leverage is the sum of the degree of operating leverage and the degree of financial leverage. True False
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f
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A firm with a high degree of combined leverage will, other things being equal, experience higher earnings in the expansionary part of the business cycle. True False
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t
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Firms with cyclical sales should employ a high degree of leverage. True False
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f
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The interwoven boundaries of banks and different trading companies in Japan make it easier to acquire credit in Japan than in the U.S. True False
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t
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For Japanese firms that have high levels of operating and financial leverage, maintaining sales volume is of critical importance even at the cost of price. True False
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t
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In order to conduct a cash break-even analysis, the analyst must add back depreciation from fixed costs. True False
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f
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An example of an adjustment for a cash break-even analysis would be adding back increases in accounts receivable. True False
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f
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Degree of combined leverage considers the impact of a change in volume on the change in operating income. True False
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f
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Financial leverage breakeven occurs when return on total assets is equal to the cost of borrowed funds. True False
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t
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Increasing financial leverage will always lead to higher EPS because it reduces the number of shares outstanding. True False
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f
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The concept of operating leverage involves the use of __________ to magnify returns at high levels of operation. A. fixed costs B. variable costs C. marginal costs D. semi-variable costs
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a
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Which of the following questions does break-even analysis attempt to address? A. How much do changes in volume affect costs and profits? B. At what point does the firm break even? C. What is the most efficient level of fixed assets to employ? D. All of the options
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d
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In break-even analysis, the contribution margin is defined as A. price minus variable cost. B. price minus fixed cost. C. variable cost minus fixed cost. D. fixed cost minus variable cost.
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a
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At the break-even point, a firm's profits are A. greater than zero. B. less than zero. C. equal to zero. D. Not enough information is given to determine.
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c
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If a firm sells 40,000 units and the contribution margin on the firm's single product is $4.00 per unit and fixed costs are $60,000, what will the firm's operating profit be at this level of sales volume? A. $100,000 B. $30,000 C. $15,000 D. $145,000
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a
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If sales volume exceeds the break-even point, the firm will experience A. an operating loss. B. an operating profit. C. an increase in plant and equipment. D. an increase in stock price.
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b
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The break-even point can be calculated as A. variable costs divided by contribution margin per unit. B. total costs divided by contribution margin per unit. C. variable costs times contribution margin per unit. D. fixed costs divided by contribution margin per unit.
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d
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A highly automated plant would generally have A. more variable than fixed costs. B. more fixed than variable costs. C. all fixed costs. D. all variable costs.
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b
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If fixed costs rise while other variables stay constant A. the break-even point rises. B. the degree of operating leverage increases. C. total profit declines. D. All of the options
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d
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If the price per unit decreases because of competition but the cost structure remains the same A. the break-even point rises. B. the degree of combined leverage declines. C. the degree of financial leverage declines. D. All of the options
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a
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If a firm has fixed costs of $60,000, a price of $7.00, and a break-even point of 25,000 units, the variable cost per unit is _____. A. $5.00 B. $4.60 C. $5.40 D. $4.00
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b
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If a firm has fixed costs of $30,000, a variable cost per unit of $.75, and a break-even point of 5,000 units, the price is _____. A. $2.50 B. $6.75 C. $4.00 D. $4.50
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b
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If a firm has a price of $6.00, a variable cost per unit of $4.00, and a break-even point of 40,000 units, fixed costs are equal to _____. A. $27,000 B. $90,000 C. $80,000 D. $50,000
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c
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If a firm with $49,000 in fixed costs breaks even on unit sales of 7,000, how many units must the firm sell to earn $30,000 in operating profit? A. 30,000 units B. 11,286 units C. 15,824 units D. There is not enough information to determine the unit sales required.
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b
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A firm has operating profit of $15,000 on unit sales of 10,000 units. Fixed costs are $30,000. What is the firm's break-even sales level? A. Less than 6,000 units. B. 6,000 units. C. More than 6,000 units D. There is not enough information to determine the unit break-even point.
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c
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A firm's break-even point will rise if A. fixed costs decrease. B. contribution margin increases. C. price per unit rises. D. variable cost per unit rises.
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d
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Davison Toaster Corp. sells its products for $150 per unit. It has the following costs: RENT $115,000 FACTORY LABOR $ 20 per unit EXEC SALARIES $ 200,000 RAW MATERIALS $ 6 per unit The break-even point is A. less than 3,000 units. B. 3,000 units. C. more than 3,500 units. D. Not enough information has been provided to determine the break-even point.
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a
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Which of the following is true about the concept of leverage? A. At the break-even point, operating leverage is equal to zero. B. Combined leverage measures the impact of operating and financial leverage on EBIT. C. Financial leverage measures the impact of fixed costs on earnings. D. None of the options
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d
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A weakness of break-even analysis is that it assumes A. revenue and costs are a linear (constant) function of volume. B. prices and costs increase when the economy is strong and confidence is high. C. the cost of goods sold goes up as revenue increases. D. None of the options
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a
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A high DOL means A. there are high labor costs. B. there is high debt. C. there is a large amount of equity. D. there are high fixed costs.
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d
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Which of the following is concerned with the change in operating profit as a result of a change in volume? A. Financial leverage B. Break-even point C. Operating leverage D. Combined leverage
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c
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Cash break-even analysis A. is helpful in analyzing the short-term outlook of the firm, particularly when it is in trouble financially. B. is important when analyzing long-term profitability. C. includes depreciation expense as a fixed cost when calculating the degree of financial leverage. D. None of the options
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a
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The degree of operating leverage may be defined as A. the percent change in operating income divided by the percent change in unit volume. B. Q(P - VC) divided by Q(P - VC) - FC. C. S - TVC divided by S - TVC - FC. D. All of the options
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d
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Loretta & Niece's fixed costs are $425,000, including $25,000 of depreciation expense. The price of each unit sold is $120, and the variable cost per unit is $60. How many units must the firm sell to reach the cash break-even point? A. Less than 7,333 units B. 7,333 units C. More than 7,333 units D. Not enough information has been provided to determine the cash break-even point.
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a
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Conservatively leveraged Firm C and highly leveraged Firm H operate at the same level of earnings before interest and taxes where the return on assets is greater than the cost of debt. A. Firm C will have a higher return on equity than H. B. Firm H will have a higher return on equity than C. C. The return on equity will not be affected by financial leverage. D. The return on equity will be the same at an equal level of earnings.
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b
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The degree of operating leverage is computed as A. percent change in operating profit divided by percent change in net income. B. percent change in unit volume divided by percent change in operating profit. C. percent change in EPS divided by percent change in operating income. D. percent change in operating income divided by percent change in unit volume.
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d
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Firm A employs a high degree of operating leverage; Firm B takes a more conservative approach. Which of the following comparative statements about firms A and B is true? A. A has a lower break-even point than B, but A's profit grows faster after the breakeven. B. A has a higher break-even point than B, but A's profit grows slower after the breakeven. C. B has a lower break-even point than A, but A's profit grows faster after the breakeven. D. B has a lower break-even point than A, and profit grows the same rate for both companies after the break-even point.
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c
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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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d
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Financial leverage deals with A. the relationship of fixed and variable costs. B. the relationship of debt and equity in the capital structure. C. the entire income statement. D. the entire balance sheet.
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b
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A conservative financing plan involves A. heavy reliance on debt. B. heavy reliance on equity. C. a high degree of financial leverage. D. a high degree of combined leverage.
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b
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A firm's earnings per share is not impacted by its financing plan at the point when A. debt is equal to equity. B. return on assets equals return on equity. C. the cost of borrowed funds equals the return on equity. D. the cost of borrowed funds equals the return on assets.
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d
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If EBIT equals $200,000 and interest equals $40,000, what is the degree of financial leverage? A. 5.33x B. 1.25x C. .8125x D. 4.33x
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b
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The degree of financial leverage is concerned with the relationship between A. changes in volume and changes in EPS. B. changes in volume and changes in EBIT. C. changes in EBIT and changes in EPS. D. changes in EBIT and changes in operating income.
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c
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When a firm employs no debt A. it has a financial leverage of one. B. it has a financial leverage of zero. C. its operating leverage is equal to its financial leverage. D. it will not be profitable.
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a
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If a firm has the lowest possible degree of operating leverage and the lowest possible degree of financial leverage, then A. DOL equals 1, and DFL equals 0. B. DOL equals 0, and DFL equals 1. C. DOL equals 1, and DFL equals 1. D. None of the options
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c
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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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b
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Which of the following is not true about leverage? A. Operating leverage influences the top half of the income statement, determining EBIT. B. Financial leverage deals with the bottom half of the income statement, determining EPS. C. Combined leverage utilizes the entire income statement, showing the impact of change in volume on EBIT. D. None of the options
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c
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If the business cycle is 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. A. Firm A B. Firm B C. Indifferent between the two D. It depends on how much financial leverage each firm has.
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a
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Sales (100,000 units) $1,000,000 Variable costs 300,000 Contribution margin 700,000 Fixed manufacturing costs 200,000 Operating income 500,000 Interest 75,000 Earnings before taxes 425,000 Taxes (30%) 127,500 Net Income $297,500Refer to the figure above. The degree of operating leverage is _____. A. 1.40x B. 1.56x C. 3.33x D. 2.22x
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a
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Sales (100,000 units) $1,000,000 Variable costs 300,000 Contribution margin 700,000 Fixed manufacturing costs 200,000 Operating income 500,000 Interest 75,000 Earnings before taxes 425,000 Taxes (30%) 127,500 Net Income $297,500Refer to the figure above. The degree of financial leverage is _____. A. 1.29x B. 4.20x C. 3.50x D. 1.18x
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d
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Sales (100,000 units) $1,000,000 Variable costs 300,000 Contribution margin 700,000 Fixed manufacturing costs 200,000 Operating income 500,000 Interest 75,000 Earnings before taxes 425,000 Taxes (30%) 127,500 Net Income $297,500Refer to the figure above. The degree of combined leverage is _____. A. 2.22x B. 1.90x C. 2.95x D. 1.65x
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d
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Sales (100,000 units) $200,000 Variable costs 110,000 Contribution margin 90,000 Fixed manufacturing costs 40,000 Operating income 50,000 Interest 10,000 Earnings before taxes 40,000 Taxes (30%) 12,000 Net Income $28,000 Shares Outstanding 1,000Refer to the figure above. This firm's break-even point is A. 445 units. B. 634 units. C. 714 units. D. 180 units.
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a
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Sales (100,000 units) $200,000 Variable costs 110,000 Contribution margin 90,000 Fixed manufacturing costs 40,000 Operating income 50,000 Interest 10,000 Earnings before taxes 40,000 Taxes (30%) 12,000 Net Income $28,000 Shares Outstanding 1,000Refer to the figure above. The degree of operating leverage (DOL) is _____. A. 1.62x B. 1.80x C. 3.50x D. 1.40x
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b
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Sales (100,000 units) $200,000 Variable costs 110,000 Contribution margin 90,000 Fixed manufacturing costs 40,000 Operating income 50,000 Interest 10,000 Earnings before taxes 40,000 Taxes (30%) 12,000 Net Income $28,000 Shares Outstanding 1,000Refer to the figure above. The degree of financial leverage (DFL) is _____. A. 3.50x B. 1.40x C. 1.95x D. 1.25x
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d
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Sales (100,000 units) $200,000 Variable costs 110,000 Contribution margin 90,000 Fixed manufacturing costs 40,000 Operating income 50,000 Interest 10,000 Earnings before taxes 40,000 Taxes (30%) 12,000 Net Income $28,000 Shares Outstanding 1,000Refer to the figure above. The degree of combined leverage (DCL) is _____. A. 3.08x B. 5.45x C. 2.25x D. 6.83x
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c
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Heavy use of long-term debt may be beneficial in an inflationary economy because A. the debt may be repaid in more "expensive" dollars. B. nominal interest rates exceed real interest rates. C. inflation is associated with the peak of a business cycle. D. the debt may be repaid in "cheaper" dollars.
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d
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Under which of the following conditions could the overuse of financial leverage be detrimental to the firm? A. In a stable industry. B. When there is cyclical demand for the firm's products. C. During an upswing in the business cycle. D. When there is low interest cost compared to return on assets.
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b
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Firm A produces semiconductors using highly technical machinery; Firm B is a retail clothing store. Consider which firm employs a higher degree of operating leverage and then answer the following question: "Which of the following comparative statements about firms A and B is true?" A. A has a lower break-even point than B, but A's profit grows faster after the breakeven. B. A has a higher break-even point than B, but A's profit grows slower after the breakeven. C. B has a lower break-even point than A, but A's profit grows faster after the breakeven. D. B has a lower break-even point than A, and profit grows at the same rate for both companies after the break-even point.
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c
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factory that relies on highly technical machinery may choose to reduce its overall leverage position by A. selling its machinery. B. increasing its accounts receivable. C. utilizing a higher level of equity. D. decreasing their variable costs per unit.
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c
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If TechCor has fixed costs of $60,000, variable costs of $1.20/unit, a sales price/unit of $7, and depreciation expense of $25,000, what is their cash breakeven in units? A. 6,034 units B. 11,458 units C. 12,375 units D. 45,833 units
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a
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From Finance in Action - Global, we can correctly assume that A. Japanese firms routinely employ high financial leverage. B. Japanese firms prefer a position of low operating leverage. C. Japanese firms tend to react aggressively to volume changes. D. Japanese firms routinely employ high financial leverage and tend to react aggressively to volume changes.
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d
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Green Co. has total assets $400,000, a cost of borrowed funds of 6%, and an EBIT of $42,500. From a financial break-even perspective, Green Co. is A. breaking even. B. lower than the breakeven point. C. higher than the break-even point. D. in need of new financing.
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c
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Match the following 1. fixed costs 2. financial leverage 3. leverage (concept in general) 4. degree of combined leverage 5. variable costs 6. combined leverage 7. degree of operating leverage 8. degree of financial leverage 9. contribution margin 10. operating leverage 11. break-even analysis 12. nonlinear break-even analysisA reflection of the extent that fixed assets and fixed costs are utilized in the business firm. ___ The amount of fixed costs covered by each unit of sales. This amount is derived by subtracting variable cost per unit from the sales price of each unit. ___ Costs that move directly with a change in volume. ___ A measure of the impact of fixed costs on earnings from the operation's viewpoint of the firm. ___ A numerical and graphical technique used to determine at what point the firm will equate its costs and revenues. ___ The use of fixed charge obligations with the intent of magnifying the potential returns to the owners of the firm. ___ A measure of the amount of debt used in the capital structure of the firm. ___ Costs that remain relatively constant regardless of the volume of sales, as long as they are within the company's relevant range. ___ A measure of the impact of debt on the earnings capability of the firm.___ The total impact of operating and financial leverage.___ The use of break-even analysis based on the assumption that cost and revenue relationships to quantity sold may vary at different levels of sales. ___ A measure of the total effect on earnings per share of operating and financial leverage. ___
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10,9,5,7,11,3,2,1,8,12,4
