Operating and Financial Leverage Assignment Part 6

Chapter 05 - Operating and Financial Leverage 86. Refer to the figure above. The Degree of Combined Leverage (D.C.L.) is A. 3.08x B. 5.45x C. 2.25x D. 6.83x 87. 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. Chapter 05 - Operating and Financial Leverage 88. Under which of the following conditions could the overuse of financial leverage be detrimental to the firm? A. Stable industry B. Cyclical demand for the firm's products. C. Upswing of business cycle. D. Low interest cost compared to return on assets 89. 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 break-even. B. A has a higher break-even point than B, but A's profit grows slower after the break-even. C. B has a lower break-even point than A, but A's profit grows faster after break-even. D. B has a lower break-even point than A, and profit grows at the same rate for both companies after the breakeven point. 90. A factory which relies on highly technical machinery, may choose to reduce their overall leverage position by A. selling their machinery B. increasing their accounts receivable C. utilizing a higher level of equity D. decreasing their variable costs per unit Chapter 05 - Operating and Financial Leverage 91. If TechCor has fixed costs of $60,000, variable costs of $1.20/unit, 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 92. Green Co. has total assets $400,000, a cost of borrowed funds of 6%, and an EBIT of $42,500. From a financial breakeven perspective, Green Co. is A. breaking even B. lower than the break even C. higher than the breakeven D. in need of new financing If maximum interest expense = $24,000 ($400,000 x 6%) and EBIT = $42,500, company must be operating above the break-even point. Chapter 05 - Operating and Financial Leverage Essay Questions 93. From the following income statement, calculate: a) Degree of financial leverage. b) Degree of operating leverage. c) Degree of combined leverage. a) b) Chapter 05 - Operating and Financial Leverage c) Chapter 05 - Operating and Financial Leverage 94. Heister Corporation produces class rings to sell to college and high school students. These rings sell for $75 each, and cost $30 each to produce. Heister has fixed costs of $45,000. a) Calculate Heister's break-even point. b) How much profit (loss) will Heister have if it sells 800 rings? 6,000 rings? c) Heister's president, J. R. D'Angelo, expects an annual profit of $200,000. How many rings must be sold to attain this profit? a) b) c) Chapter 05 - Operating and Financial Leverage 95. A new restaurant is ready to open for business. It is estimated that the food cost (variable cost) will be 30% of sales, while fixed cost will be $540,000. The first year's sales estimates are $1,500,000. The cost to start up this restaurant will be $2,000,000. Two financing alternatives are being considered: a) 50% equity financing and 50% debt at 9%, or b) all equity financing. Common stock can be sold at $5 per share. a) Compute the Operating Break-even point in dollars. b) Compute DOL. c) Compute DFL and DCL for both financing plans. Chapter 05 - Operating and Financial Leverage a) b) c) Chapter 05 - Operating and Financial Leverage Chapter 05 - Operating and Financial Leverage Matching Questions 96. Match the following with the items below: 1. degree of financial leverage 2. combined leverage 3. degree of operating leverage 4. variable costs 5. Contribution margin 6. Operating leverage 7. fixed costs 8. financial leverage 9. nonlinear breakeven analysis 10. degree of combined leverage 11. leverage (concept in general) 12. break-even analysis A reflection of the extent fixed assets and fixed costs are utilized in the business firm. 6 The amount of fixed costs covered by each unit of sales. This amount is derived by subtracting variable costs from the sales price of each unit. 5 Costs that move directly with a change in volume. A measure of the impact of fixed costs on earnings from the operations 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 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. 4 3 12 11 8 7 1 2 9 10