FIN 3400 Ch. 5 HW Questions: Operating and Financial Leverage
If fixed costs rise while other variables stay constant
* the break-even point rises. * the degree of operating leverage increases. * total profit declines.
Which of the following is true about the concept of leverage?
** None of the options are true.** - At the break-even point, operating leverage is equal to zero; - Combined leverage measures the impact of operating and financial leverage on EBIT; - Financial leverage measures the impact of fixed costs on earnings.
If a firm with $49,000 in fixed costs breaks even on 7,000 units, how many units must the firm sell to earn $30,000 in operating profit?
11,286 units (P - VC) = CM 7000 = 49,000/CM; 49000/7000 CM = $7 Q= Profit + FC/ (P - VC) Q = 30,000 + 49,000/ $7 = 11,286 units
Firm A produces semiconductors using highly technical machinery; Firm B is a retail clothing store with little use of machinery. 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?"
B has a lower break-even point than A, but A's profit grows faster after the breakeven.
Which of the following is not true about leverage?
Combined leverage utilizes the entire income statement, showing the impact of change in volume on EBIT.
Contribution margin is equal to fixed costs minus variable costs.
F
Degree of combined leverage considers the impact of a change in volume on the change in operating income.
F
If a firm has a degree of financial leverage (DFL) of 2.0, earnings per share will change 2% for every 1% change in sales volume.
F
Operating income is not the same thing as earnings before interest and taxes (EBIT).
F
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.
F
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 in units?
More than 6,000 units profit = q (p -vc)- FC q (p - vc)= profit + fc q = Profit + fc/ P - vc 10,000 = 15,000+30,000/ p - vc 10,000 = 45,000/ p - vc P- VC = $4.50 BE = F/ P - VC; 30,000/ $4.50 = 6,667 units
Which of the following is concerned with the change in operating profit as a result of a change in unit volume?
Operating leverage
"Operating leverage" is the use of fixed costs to magnify returns at high levels of operation.
T
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.
T
Cash break-even analysis eliminates the non-cash charges from fixed costs in order to obtain the amount of quantity sold is necessary in order for cash inflow to equal the cash outflow.
T
Linear break-even analysis assumes that the change in costs have the same relationship with the change in volume.
T
Management should tailor the use of leverage to meet the company's own risk-taking desires.
T
Managers who are risk-averse and uncertain about the future would most likely minimize combined leverage.
T
Operating leverage primarily affects the asset side of the balance sheet, while financial leverage affects the liabilities and net worth side of the balance sheet.
T
Operating leverage will change when a firm alters the mix of fixed capital resources and variable labor that it uses.
T
Operating leverage works best when product volume is increasing.
T
Sales commissions and raw materials are variable costs.
T
The degree of financial leverage measures the percentage change in earnings per share (EPS) for every percentage change in earnings before interest and taxes (EBIT).
T
Under which of the following conditions could the overuse of financial leverage be detrimental to the firm?
When there is cyclical demand for the firm's products.
The degree of financial leverage is concerned with the relationship between
changes in EBIT and changes in EPS.
Combined leverage is concerned with the relationship between
changes in volume and changes in EPS.
At the break-even point, a firm's profits are
equal to zero
A highly automated plant would generally have
more fixed than variable costs
A weakness of break-even analysis is that it assumes
revenue and costs are a linear (constant) function of volume.
In break-even analysis, the contribution margin is defined as
sales price minus variable cost.
A firm's earnings per share is not impacted by its financing plan at the point when
the cost of borrowed funds equals the return on assets.
Heavy use of long-term debt may be beneficial in an inflationary economy because
the debt may be repaid in "cheaper" dollars.
Financial leverage deals with
the relationship of debt and equity in the capital structure.
A firm's break-even point will rise if
variable cost per unit rises.
