Chapter 5: CONNECT HW

The price of a firm's product is $10, variable costs are $4, and fixed costs per unit are $2. What is the contribution margin?

$6 Reason: CM = P - VC CM = $10 unit - $4/unit = $6/unit

Variable costs include

raw materials sales commissions factory labor

At high levels of operation, the potential profit for a firm that is highly leveraged is ______ compared to those of a firm that is not highly leveraged.

relatively large

Fixed costs ______ as the number of units produced increases.

remain the same

The closer DOL is computed to the company break-even point, the ______ DOL number will be due to a large percentage increase in operating income.

higher

Operating and financial leverage enable a firm to magnify its

returns

Semi-variable costs ______ as the number of units produced increases.

increase

The total _____ line is based on the volume times the price.

revenue

Break-even analysis is employed to evaluate

operating leverage

Contribution margin is

price minus variable cost per unit.

Contribution margin is defined as

price per unit - variable costs per unit

Semi-variable costs include

utilities repairs maintenance

The higher a firm's degree of operating leverage, the greater the increase in income as ______.

volume expands.

A company producing and selling 70,000 units has a DOL of 1.5, which indicates that at 70,000 units a

1% increase in sales volume will produce a 1.5% increase in operating income Reason: DOL = % change in EBIT / % change in Sales. So, DOL = 1.5 X 1% incr Sales = 1.5% incr in EBIT.

A company has sales of $2,250,000 (30,000 units at $75 each), variable costs of $25 per unit, fixed costs of $400,000, interest expense of $100,000, and a tax rate of 30%. What is the company's degree of financial leverage?

1.1 Reason: EBIT = (30K X ($75-$25)) -$400K = $1.1M DFL =$1.1M/($1.1M-$100K) = 1.1

Company A and B both have sales of $1,200,000 (20,000 units at a price of $60 each). Company A has variable costs of $30 per unit, fixed costs totaling $400,000, and interest of $25,000. Company B has variable costs of $20 per unit, fixed costs totaling $600,000, and interest of $50,000. Company A's DFL is ______ and Company B's DFL is ______

1.14, 1.33

A company has fixed costs of $20,000, variable costs of $1.00 per unit, and a price of $3.00 per unit, the company's break-even point is _______ units.

10,000 Fixed costs/ price - variable costs

A firm has fixed costs of $80,000, a depreciation expense of $10,000, and a contribution margin of $0.70. So, the break-even point in units on a strictly cash basis is ______ ?

100,000

A degree of combined leverage of 2 indicates that a 1% change in sales will be reflected by a ______ % change in earnings per share.

2

At an EBIT level of $40,000 and a DFL of 2, a 1 percent increase in earnings will produce a ______ percent increase in earnings per share.

2

Company A and B both have sales of $1,200,000 (20,000 units at a price of $60 each). Company A has variable costs of $30 per unit and fixed costs totaling $400,000. Company B has variable costs of $20 per unit and fixed costs totaling $600,000. Company A has a DOL ______ of and Company B has a DOL of ______

3, 4 DOL = (P-VC)/ (P-VC) - FC

A company has sales of $1,200,000 (20,000 units at a price of $60 each), variable costs of $30 per unit, fixed costs of $400,000, interest expense of $50,000, and a tax rate of 30%. What is the company's degree of combined leverage?

4

The company has fixed costs of $20,000 and a contribution margin of $0.50, the company's break-even point is _______ units?

40,000 Fixed costs/ contribution margin

Company A has sales of $1,200,000 for 20,000 units sold, variable costs of $25 per unit, and fixed costs totaling $560,000. The company's degree of operating leverage is

5

Using EBIT instead of Net Income, in the return on assets ratio nulls the effects of the different capital structures and tax rates used by different companies. With this in mind, if company A has an EBIT of $15,000 and total assets of $199,000 what is the company earning on its assets? Give your answer in percent to two decimal places.

7.54% Reason: ROA = EBIT/TA = $15K / $199K = 7.54%

______ can be used to determine how much changes in volume affect costs and profits.

Break-even analysis

Company A and B both have sales of $1,200,000 (20,000 units at a price of $60 each). Company A has variable costs of $30 per unit, fixed costs totaling $400,000, and interest of $50,000. Company B has variable costs of $20 per unit, fixed costs totaling $600,000, and interest of $25,000. Which company has the greatest degree of combined leverage?

Company B Reason: DCLa = 20K units X ($60/unit - $30/unit)/(20K units X ($60/unit - $30/unit) - $400K - $50K) = 4.0 DCLb = 20K units X ($60/unit - $20/unit)/(20K units X ($60/unit - $20/unit) - $600K - $25K) = 4.57

Using cash break-even analysis, what is deducted from fixed costs to arrive at the break-even point?

Depreciation

Substantial use of debt will magnify ______ as volume or operating income increases.

EPS

Firms with a high degree of leverage are less dependent on volume than firms with a low degree of leverage.

False

The amount of a company's sales will accurately reflect its cash inflow.

False

Break-even analysis is used to answer which of the following question(s)?

How much will changes in volume affect profit?

______ leverage reflects the extent to which fixed assets and associated fixed costs are utilized in the business.

Operating

The area on the break-even chart above the break-even point represents

The profitable range of a firm's operations.

Firms that are in financial trouble frequently utilize a cash break-even analysis.

True

Total costs are dependent on the company's volume.

True

Depreciation is an ______ flow that represents a noncash accounting entry.

accounting

Besides depreciation, what other noncash items can be adjusted when using cash break-even analysis.

accounts payable accounts receivable

The use of debt is recommended for firm's in industries that

are operating under positive economic conditions are in a positive stage of growth offer some degree of stability

A firm that is unable to make its debt payments may be subject to ______.

bankruptcy

To evaluate the implications of using heavy fixed assets, a firm can employ the technique of

break-even analysis

Maximum leverage can be achieved through the use of ______ leverage.

combined (operating + financial)

When management expects an economic downturn it may be in the firms best interest to undertake a(n) ______ plan.

conservative

Once the company produces and sells the units required to break-even, each additional sale will increase profit by an amount equal to the

contribution margin

The firm can finance the business using ______?

debt and equity

Variable costs include all of the following except

depreciation

A company employing heavy financial leverage has a cost to borrow of 8% and return on assets of 10%. As EBIT increases the firm will greatly expand its ______

earnings per share.

Which factor(s) influence management's decision to follow a more aggressive approach to the firm's leverage or a more conservative approach?

economic conditions the firm's competitive position management's own risk taking desires growth of the business

Operating leverage is defined as the

extent to which fixed assets and associated fixed costs are used in the business

All of the following are considered semi-variable costs except

factory labor

Debt and equity are methods used to

finance a business.

The extent with which debt is utilized in the firm is known as

financial leverage

Firms that take a conservative approach to the use of operating leverage may increase variable costs in lieu of adding ________ costs.

fixed

A firm must first determine the amount of which types of costs to be used in the production process.

fixed costs

A simple formula for determining a firm's break-even point is

fixed costs divided by contribution margin per unit

Assuming that the break-even point has been surpassed, a firm that utilizes a high degree of operating leverage will produce ______ profits than a firm that utilizes a lower degree of operating leverage.

greater

The _____ axis of the break-even chart shows the number of units produced and sold.

horizontal or x

Leverage looks at

how long term debt is used to finance the business

During an economic upturn, when a firm's sales volume is high, a firm that has high fixed costs may ______?

incur a greater percentage of profit than a firm with high variable costs

The production process requires that management determine the amount of ______ to be used.

labor plant and equipment

Assuming the break-even point has been surpassed, a firm that utilizes a low degree of operating leverage will produce ______ profit compared to a firm that utilizes a higher degree of operating leverage.

less

The area below the break-even point represents ______ to the firm.

losses

Substantial use of debt will place a large burden on the firm at (high or low) ______ levels of profitability.

low

During an economic downturn, when a firm's sales volume is low, a firm that has high variable costs may ______.

lower its exposure to risk.

Firms that rely on equity financing will

lower their profit potential. minimize their risk exposure.

Financial leverage ______

may increase a company's return on equity

In accounting and finance, depreciation represents a(n)

non-cash outlay

The horizontal axis of the break-even chart represents the

number of units produced and sold

The extent with which fixed costs are used in the operations of the firm is known as

operating leverage

Degree of financial leverage is defined as

percent change in earnings per share divided by percent change in earnings before interest and taxes

The degree of combined leverage is the

percent change in earnings per share divided by the percent change in sales

The degree of operating leverage can be defined as the

percent change in operating income divided by the percent change in unit volume

At high levels of operation, the profit potential for a firm that is not highly leveraged is ______ compared to that of a highly leveraged firm.

relatively small Reason: The use of leverage in a firm magnifies the profit potential, but also the loss potential if things don't go as planned.

The vertical axis of the break-even chart represents the

revenues and costs

Cash break-even analysis is helpful in analyzing the ______ outlook of the firm, particularly when the firm may be in trouble.

short-term

Firms with a lower degree of operating leverage will have a

small loss potential and small profit potential

Financial leverage is defined as

the amount of debt used in the capital structure of the firm

The break-even point is

the point in units where total revenue equals total costs

The line on the break-even chart that starts with fixed costs at the vertical axis and increases by the amount of the variable costs per additional units produced represents the firm's ______?

total cost curve Reason: Total costs = Fixed Costs + Total Variable Costs (i.e., the number of units sold during the period times the COGS).

The break-even point occurs when the company's

total revenue = fixed costs + variable costs

The curve on the break-even chart that starts at zero on the vertical axis and increases by the amount of the product's price represents the firm's ______?

total revenue curve

The _____ axis of the break-even chart shows the revenue and costs.

vertical or y

Financial leverage reflects the amount of fixed costs used by the firm.

False

Debt financing can be advantageous to a firm, but only up to a point.

True

All of the following are considered fixed costs except

factory labor