finance test 3 CH 12
A decrease in fixed financial costs will result in a(n)________. A) increase in financial risk B) decrease in financial risk C) increase in operating leverage D) decrease in operating leverage
B
An increase in fixed operating costs will result in ________. A) a decrease in the degree of operating leverage B) an increase in the degree of operating leverage C) a decrease in the degree of financial leverage D) an increase in the degree of financial leverage
B
One function of breakeven analysis is to ________. A) determine the profit attributable to each stockholder B) evaluate the effect of leverage on a firm's risks and returns C) evaluate the profitability of various sales levels D) determine the amount of financing needed by the firm
C
________ analysis is a technique used to assess the returns associated with various cost structures and levels of sales. A) Time-series B) Marginal C) Breakeven D) Ratio
C
As fixed operating costs increase and all other factors are held constant, ________. A) the degree of operating leverage will increase B) the degree of operating leverage will decrease C) the degree of total leverage will decrease D) the degree of total leverage will increase
B
If a firm's sale price per unit decreases, the firm's ________. A) operating breakeven point will decrease B) operating breakeven point will increase C) variable costs per unit will decrease D) variable costs per unit will increase
B
If a firm's variable costs per unit increase,the firm's ________. A) financial breakeven point will decrease B) operating breakeven point will increase C) sale price per unit will decrease D) fixed costs per unit will increase
B
According to the traditional approach to capital structure, the value of a firm will be maximized when ________. A) the financial leverage is maximized B) the cost of debt is minimized C) the weighted average cost of capital is minimized D) the dividend payout is maximized
C
After satisfying obligations to creditors, the government, and preferred stockholders, any remaining earnings will most likely be allocated to ________. A) common shareholders as cash dividends B) common shareholders as stock dividends C) other firms requiring capital D) pay future preferred dividends
A
As debt is substituted for equity in the capital structure and the debt ratio increases, the behavior of the overall cost of capital is partially explained by ________. A) the tax-deductibility of interest payments B) the increase in the number of common shares outstanding C) the reduction in risk as perceived by the common shareholders D) the decrease in the cost of equity
A
Earnings before interest and taxes (EBIT) is a descriptive label for ________. A) operating profits B) net profits before taxes C) earnings per share D) gross profits
A
If a firm's fixed operating costs decrease, the firm's ________. A) operating breakeven point will decrease B) operating breakeven point will increase C) sale price per unit will decrease D) sale price per unit will increase
A
In the traditional approach to capital structure, as the amount of debt increases in a firm's capital structure, ________. A) the cost of equity rises faster than the cost of debt B) the cost of debt rises faster than the cost of equity C) debt becomes less risky D) equity cost is unaffected
A
Operating leverage measures the effect of fixed operating costs on the relationship between ________. A) sales and EBIT B) sales and EPS C) EBIT and EPS D) EBIT and dividend
A
Poor capital structure decisions can result in ________ the cost of capital, resulting in ________ acceptable investments. A) increasing; fewer B) decreasing; more C) increasing; more D) decreasing; fewer
A
The conflict resulting from a manager's desire to increase a firm's risk without increasing current borrowing costs and lenders' desire to limit lending is one effect of the ________ problem. A) agency B) leverage C) capital D) variable cost
A
The major shortcoming of the EBIT-EPS approach to capital structure is that ________. A) the technique does not promote the maximization of shareholder wealth B) the technique does not consider the cost of capital C) the technique only considers leverage-related risk D) the technique does not maximize earnings per share
A
The reason why maximizing share value and maximizing EPS do not give the same optimal capital structure is because ________. A) EPS maximization does not consider risk B) share value maximization does not consider risk C) EPS maximization considers cash flows D) EPS maximization does consider risk
A
Through the effects of financial leverage, when EBIT increases, ________. A) earnings per share will increase B) earnings per share will decrease C) fixed operating costs will decrease D) fixed operating costs will increase
A
Which of the following affects business risk? A) revenue stability B) financial leases C) operating leverage D) preferred stock
A
Beginning with a zero-leverage company, as debt is substituted for equity in the capital structure ________. A) the overall cost of capital first rises, reaches a maximum, and then declines B) the overall cost of capital declines C) the overall cost of capital first declines, reaches a minimum, and then rises D) the overall cost of capital rises
C
Breakeven analysis is used by a firm ________. A) to determine the level of operations necessary to cover all fixed operating costs B) to determine the least cost of producing goods and services C) to evaluate the profitability associated with various levels of sales D) to determine the demand of a product
C
Financial leverage measures the effect of fixed financial costs on the relationship between ________. A) sales and EBIT B) sales and EPS C) EBIT and EPS D) EBIT and preference dividend
C
Financial leverage measures the effect of fixed financing costs on the relationship between ________. A) sales and EBIT B) sales and EPS C) EBIT and EPS D) net income and sales
C
Fixed financial charges include ________. A) common stock dividends and bond interest expense B) common stock dividends and preferred stock dividends C) bond interest expense and preferred stock dividends D) stock repurchase expense
C
Generally, increases in leverage result in ________ return and ________ risk. A) decreased; increased B) decreased; decreased C) increased; increased D) increased; decreased
C
Higher financial leverage causes ________ to increase more for a given increase in ________. A) EBIT; sales B) EPS; sales C) EPS; EBIT D) EBIT; EPS
C
If a firm's fixed financial costs decrease, the firm's operating breakeven point will ________. A) decrease B) increase C) remain unchanged D) change based on the sale price per unit
C
In case of a manufacturing organization, which of the following is a variable cost that varies directly with the sales volume? A) interest cost B) dividend cost C) shipping cost D) rental cost
C
In the EBIT-EPS approach to capital structure, risk is represented by ________. A) the slope of the capital market line B) shifts in the cost of debt capital C) the slope of the capital structure line D) shifts in the times-interest-earned ratio
C
In theory, a firm should maintain financial leverage consistent with a capital structure that ________. A) meets the industry standards B) meets the investor expectations C) maximizes the owner's wealth D) maximizes dividends
C
Revenue stability affects ________. A) dividend risk B) maturity risk C) business risk D) interest rate risk
C
The EBIT-EPS approach to capital structure proposes that an optimal capital structure be selected which ________. A) maximizes the weighted average cost of capital B) minimizes the cost of debt C) maximizes the EPS D) minimizes dividends
C
The degree of financial leverage is the ratio of ________ to percentage change in EBIT. A) operating profit B) percentage change in sales C) percentage change in EPS D) long-term debt
C
The inexpensive nature of long-term debt in a firm's capital structure is due to the fact that ________. A) the debt holders are the true owners of the firm B) equity capital has a fixed return C) long-term debt has a fixed return and a maturity date D) dividend payments are tax-deductible
C
The inexpensive nature of long-term debt in a firm's capital structure is due to the fact that ________. A) the equity holders are the true owners of the firm B) equity capital has a fixed return C) creditors have a higher position in the priority of claims D) dividend payments are tax-deductible
C
The inexpensive nature of long-term debt in a firm's capital structure is due to the fact that ________. A) the equity holders are the true owners of the firm B) equity capital has a fixed return C) interest payments are tax-deductible D) equity holders have a higher position in the priority of claims
C
The lower risk nature of long-term debt in a firm's capital structure is due to the fact that ________. A) the debt holders are the true owners of the firm B) equity capital has a fixed return C) creditors have a higher position in the priority of claims D) dividend payments are tax-deductible
C
The optimal capital structure is the one that balances ________. A) return and risk factors in order to maximize profits B) return and risk factors in order to maximize earnings per share C) return and risk factors in order to maximize market value D) return and risk factors in order to maximize dividends
C
Which of the following is a difference between debt and equity capital? A) Debt capital does not require periodic payments, whereas equity capital requires period payments. B) Debt capital requires returns in proportion to profits, whereas equity capital requires a fixed rate of return. C) Debt capital provides a tax shield, whereas equity capital does not provide a tax shield. D) Debt capital affects operating leverage, whereas equity capital affects financial leverage.
C
________ is the risk of being unable to cover financial obligations of a firm. A) Systematic risk B) Business risk C) Financial risk D) Diversifiable risk
C
________ results from the use of fixed-cost assets or funds to magnify returns to a firm's owners. A) Long-term debt B) Equity C) Leverage D) Capital structure
C
A decrease in fixed operating costs will result in ________ in the degree of financial leverage. A) a decrease B) an increase C) no change D) an undetermined change
D
A firm's operating breakeven point is the point at which ________. A) total operating costs equal total fixed costs B) total operating costs are zero C) EBIT is less than sales D) EBIT is zero
D
At the operating breakeven point, ________ equals zero. A) sales revenue B) fixed operating costs C) variable operating costs D) earnings before interest and taxes
D
Because the degree of total leverage is multiplicative and not additive, when a firm has very high operating leverage it can moderate its total risk by ________. A) increasing sales B) using a higher level of financial leverage C) increasing EBIT D) using a lower level of financial leverage
D
The basic shortcoming of the EBIT-EPS approach to capital structure is ________. A) that the optimal capital structure is difficult to compute B) its disregard for the presence of preferred stock in the capital structure C) its disregard for the firm's dividend policy D) that it concentrates on the maximization of EPS rather than the maximization of owner's wealth
D
The cost of debt financing results from ________. A) the decreased probability of bankruptcy caused by debt obligations B) the risk-return trade-off associated with ownership of a firm C) the costs associated with lenders having less information about a firm's prospects than investors and managers D) the agency costs of the lenders' monitoring and controlling a firm's actions
D
Which of the following is true of leverage? A) It refers to the effects that operating and financial fixed costs have on the returns that shareholders earn. B) It is associated with risks which are out of the control of managers. C) It includes the effect of operating fixed costs on the returns of shareholders and not the financial fixed costs. D) It is used to evaluate the profitability associated with various levels of sales.
A
________ costs are a function of time, not sales, and are typically contractual. A) Fixed B) Semi-variable C) Variable D) Operating
A
________ is the potential use of fixed financial charges to magnify the effects of changes in earnings before interest and taxes on a firm's earnings per share. A) Financial leverage B) Operating leverage C) Total leverage D) Degree of operating leverage
A
________ leverage is concerned with the relationship between earnings before interest and taxes and earnings per share. A) Financial B) Operating C) Variable D) Total
A
In the EBIT-EPS approach to capital structure, a constant level of EBIT is assumed ________. A) to ease the calculations of owners' equity B) to isolate the impact on returns of the financing costs associated with alternative capital structures C) to emphasize the relationship between interest expenses and taxes D) to concentrate on the effect of revenue and expense on capital structure decisions
B
Management has just discovered an excellent investment for which it needs additional funding. Relative to the discussion on asymmetric information, the firm should ________. A) finance with new common stock if management believes the firm is undervalued B) finance with debt if management believes the firm is undervalued C) finance with debt if management believes the firm is overvalued D) finance with preferred stock if the firm is at value
B
Operating and financial constraints placed on a corporation by loan provision are ________. A) agency costs to lenders B) agency costs to a firm C) necessary to regulate ownership of a firm D) necessary to control the risk of a firm
B
The preferred approach to breakeven analysis for a multiproduct firm is the ________. A) breakeven point expressed in units B) breakeven point expressed in dollars C) cash breakeven point D) overall breakeven point
B
The value of a firm at optimum capital structure is computed as ________. A) earnings before interest and taxes times one less tax rate divided by one plus weighted average cost of capital B) earnings before interest and taxes times one less tax rate divided by weighted average cost of capital C) operating cash flow divided by weighted average cost of capital D) operating cash flow divided by one plus weighted average cost of capital
B
Total leverage measures the effect of fixed costs on the relationship between ________. A) sales and EBIT B) sales and EPS C) EBIT and EPS D) EBIT and dividend
B
Which of the following affects business risk? A) operating leverage B) interest rate stability C) preferred stock D) financial lease
B
Which of the following is a difference between debt and equity capital? A) Debt capital does not require periodic payments, whereas equity capital requires period payments. B) Debt capital requires a fixed rate of return, whereas equity capital requires returns in proportion to profits. C) Debt capital does not provides a tax shield, whereas equity capital provides a tax shield. D) Debt capital affects operating leverage, whereas equity capital affects financial leverage.
B
Which of the following is a fixed cost? A) inventory B) rent C) delivery costs D) direct labor
B
Which of the following is the correct order in which corporations generally raise funds to enhance the wealth of stockholders and to send positive signals to the market? A) retained earnings, equity, debt B) retained earnings, debt, equity C) debt, retained earnings, equity D) equity, retained earnings, debt
B
________ is 100 percent minus total variable operating costs as a percentage of total sales. A) Profit margin B) Contribution margin C) Expense ratio D) Fixed coverage ratio
B
________ is the potential use of fixed costs to magnify the effect of changes in sales on the firm's earnings per share. A) Investing leverage B) Total leverage C) Operating leverage D) Financial leverage
B
________ is the potential use of fixed operating costs to magnify the effects of changes in sales on earnings before interest and taxes. A) Financial leverage B) Operating leverage C) Operating budget D) Ratio analysis
B
________ is the risk of being unable to cover operating costs of a firm. A) Systematic risk B) Business risk C) Financial risk D) Diversifiable risk
B
________ leverage is concerned with the relationship between sales revenues and earnings before interest and taxes. A) Investing B) Operating C) Variable D) Total
B
________ leverage measures the effect of fixed ________ costs on the relationship between EBIT and EPS. A) Operating; operating B) Financial; financial C) Operating; financial D) Financial; operating
B
________ refers to the effects that fixed costs have on the returns that shareholders earn. A) Purchase power parity B) Leverage C) Business risk D) Pecking order theory
B
A firm has fixed operating costs of $525,000. The sales price per unit is $35 and its variable costs per unit is $22.50. The firm's operating breakeven point in units is ________. A) $23,330 B) $32,000 C) $42,000 D) $52,000
C
A firm's ________ is the level of sales necessary to cover all operating costs, i.e., the point at which EBIT equals zero. A) cash breakeven point B) financial breakeven point C) operating breakeven point D) total breakeven point
C
A firm's ________ is the mix of long-term debt and equity utilized by the firm, which may significantly affect its value by affecting return and risk. A) dividend policy B) capital budget C) capital structure D) working capital
C
A major assumption of breakeven analysis and one which causes severe limitations in its use is that ________. A) fixed costs really are fixed B) total revenue is nonlinear C) revenues and operating costs are linear D) all costs are really semi-variable
C
The risk of the debt capital is less than that of other long-term contributors of capital because ________. A) they have a lower priority of claim against any earnings or assets available for payment B) they have the stockholders' personal assurance for all future interest payments C) there is no interest rate risk as the interest rate is predetermined D) the tax-deductibility of interest payments lowers the debt cost to a firm substantially
D
The three basic types of leverage are ________. A) operating, production, and financial B) operating, production, and total C) production, financial, and total D) operating, financial, and total
D
Which of the following is a basic source of capital for a firm? A) short-term debt B) discounts from suppliers C) current liabilities D) common stock
D
Which of the following is a reason why equity capital is considered riskier than debt capital? A) Equity capital has a higher priority claim against assets and earnings. B) Equity capital requires regular periodic payments in the form of dividends. C) Equity capital expects dividend payments which are not tax-deductible. D) Equity capital remains invested in a firm indefinitely.
D
With the existence of fixed operating costs, a decrease in sales will result in ________ in EBIT. A) a proportional increase B) an equal increase C) a less than proportional decrease D) a more than proportional decrease
D
With the existence of fixed operating costs, an increase in sales will result in ________ increase in EBIT. A) a proportional B) an equal C) a less than proportional D) a more than proportional
D
________ costs require the payment of a specified amount in each accounting period. A) Operating B) Variable C) Semi-variable D) Fixed
D
________ leverage is concerned with the relationship between sales revenue and earnings per share. A) Financial B) Operating C) Variable D) Total
D
