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Capital Structure Multiple Choice

True/ False: 2 points each
1. The degree of operating leverage is an index number that measures the effect of a change in sales price on the operating breakeven point__________.
2. The degree of financial leverage gives an indication of how a change in EBIT will affect EPS_________.
3. Other things held constant, a high degree of total leverage will mean that a relatively small change in sales will result in a large change in EBIT__________.
4. In general, excess capacity means more external financing is required to support increases in operations than would be needed if the firm previously operated at full capacity_________.
5. A firm that only utilizes 40% of its fixed asset capacity to generate $1,000,000 in sales will be able to increase sales to $4,000,000 before full capacity is reached and plant and equipment would have to be increased__________.
6. The degree of total leverage shows how a change in sales will affect earnings per share__________.
7. The operating breakeven volume in units can be found by dividing the firm's total fixed costs in dollars by its contribution margin per unit (i.e. sales price minus variable cost per unit)________.
8. Other things held constant, the greater the firm's use of debt, the greater the change in EPS that will result from a change in sales volume__________.
9. Everything else equal, the higher a firm's DFL, the closer it is to its operating breakeven point_______.

Multiple Choice: 2 points each
1. The degree of financial leverage for ABC Inc. is 2.5, and the degree of financial leverage for XYZ Corp., is 1.5. Based upon this information only, which firm is considered to have the greater financial risk?
a) ABC Inc.
b) XYZ Corporation
c) Financial leverage is not a measure of financial risk, so it is not possible to tell
d) Cannot be determined without knowing the EBIT of each firm
e) None of the above

2. Which of the following is a key determinant of financial leverage?
a) Level of debt
b) Technology
c) Labor Costs
d) Amount of fixed assets used by the firm
e) Variable cost of goods sold

3. Which of the following liabilities is most likely to increase spontaneously with an increase in sales?
a) Notes payable
b) Long-term bonds
c) Preferred stock
d) Accounts payable
e) Common stock

4. Which of the following will not rise spontaneously with an increase in sales?
a) Accounts payable
b) Accrued wages
c) Accrued taxes
d) Accounts receivable
e) Notes payable

5. The decision of how to raise additional funds needed to support sales growth is based on several factors including:
a) Firms' ability to handle additional debt
b) Conditions in the equity markets
c) Firm's current capital structure.
d) Existing debt covenants.
e) All of the above.

6. All else equal, which of the following activities should increase the financial risk of a firm?
a) Decrease common stock dividends
b) Issue new bonds
c) Issue new common stock
d) Repurchase (pay off) outstanding debt
e) An increase in the fixed operating costs

Solution Preview

True/ False: 2 points each
1. The degree of operating leverage is an index number that measures the effect of a change in sales price on the operating breakeven point__________. False
It measures the effect of a change in sales price on the operating income.

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

3. Other things held constant, a high degree of total leverage will mean that a relatively small change in sales will result in a large change in EBIT__________.
True.

4. In general, excess capacity means more external financing is required to support increases in operations than would be needed if the firm previously operated at full capacity_________.
False. ( Less funds will be required)

5. A firm that only utilizes 40% of its fixed asset capacity to generate $1,000,000 in sales will be able to increase ...

Solution Summary

Solution discusses the degree of operating leverage

$2.19