Operating and Financial Leverage Assignment Part 3

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 A reflection of the extent fixed assets and fixed costs are utilized in the business firm. ____ 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. ____ Costs that move directly with a change in volume. A measure of the impact of fixed costs on earnings 4. variable costs from the operations viewpoint of the firm. A numerical and graphical technique used to 5. Contribution determine at what point the firm will equate its costs margin and revenues. The use of fixed charge obligations with the intent of magnifying the potential returns to the owners of 6. Operating the firm. leverage A measure of the amount of debt used in the capital 7. fixed costs structure of the firm. Costs that remain relatively constant regardless of 8. financial leverage the volume of sales 9. nonlinear breakA measure of the impact of debt on the earnings even analysis capability of the firm. 10. degree of The total impact of operating and financial combined leverage leverage. The use of break-even analysis based on the 11. leverage (concept assumption that cost and revenue relationships to in general) quantity sold may vary at different levels of sales. 12. break-even A measure of the total effect on earnings per share analysis of operating and financial leverage. ____ ____ ____ ____ ____ ____ ____ ____ ____ ____ Chapter 05 - Operating and Financial Leverage Chapter 05 Operating and Financial Leverage Answer Key True / False Questions 1. Leverage is the use of fixed costs to magnify returns at high levels of operation. TRUE 2. Leverage works best when volume is increasing. TRUE 3. Operating leverage emphasizes the impact of using fixed assets in the business. TRUE 4. Financial leverage emphasizes the impact of using debt in the business. TRUE Chapter 05 - Operating and Financial Leverage 5. Operating leverage determines how income from operations is to be divided between debt holders and stockholders. FALSE 6. Operating leverage will change when a firm alters the mix of fixed capital resources and labor that it uses. TRUE 7. Contribution margin is equal to fixed costs minus variable costs. FALSE 8. Property Taxes and depreciation expense are examples of variable costs. FALSE 9. Sales commissions and raw material are variable costs. TRUE Chapter 05 - Operating and Financial Leverage 10. The contribution margin is equal to price per unit minus total costs per unit. FALSE 11. As the contribution margin rises, the breakeven point goes down. TRUE 12. A lower price for the firm's product will reduce the firm's breakeven point. FALSE 13. If economic conditions were expected to be favorable, an investor would likely prefer a firm with a low degree of leverage. FALSE 14. Use of financial leverage must consider risk, not just maximizing profit. TRUE Chapter 05 - Operating and Financial Leverage 15. For firms in industries that offer some degree of stability, are in a positive stage of growth, and are operating in favorable economic condition, the use of debt is not needed or recommended. FALSE 16. Managers who are risk averse and uncertain about the future would most likely minimize combined leverage. TRUE 17. Management should tailor the use of leverage to meet its own risk-taking desires. TRUE 18. Cash breakeven analysis eliminates the depreciation expense and other non-cash charges from fixed costs. TRUE Chapter 05 - Operating and Financial Leverage 19. 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. FALSE 20. The closer a firm is to its break-even point, the lower the degree of operating leverage will be. FALSE 21. Degree of operating leverage should be computed only over a profitable range of operations. TRUE 22. Linear break-even analysis assumes that costs are linear functions of volume. TRUE Chapter 05 - Operating and Financial Leverage 23. Linear breakeven analysis and operating leverage are only valid within a relevant range of production. TRUE 24. Financial leverage primarily affects the left-hand side of the balance sheet. FALSE 25. Operating leverage primarily affects the left hand side of the balance sheet while financial leverage affects the right hand side of the balance sheet. TRUE 26. The degree of financial leverage measures the percentage change in EPS for every 1 percent move in EBIT. TRUE Chapter 05 - Operating and Financial Leverage 27. If a firm has a DFL of 2.0, EPS will change 2% for every 1% change in volume. FALSE 28. The degree of financial leverage is not influenced by the interest rate on debt, only the amount borrowed. FALSE 29. A firm with a high degree of financial leverage could face financial difficulty even though it is in a stable industry. TRUE 30. Operating income is not the same thing as EBIT. FALSE Chapter 05 - Operating and Financial Leverage 31. Operating leverage influences the bottom half of the income statement while financial leverage deals with the top half. FALSE 32. The degree of combined leverage is the sum of the degree of operating leverage and the degree of financial leverage. FALSE 33. 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. TRUE 34. Firms with cyclical sales should employ a high degree of leverage. FALSE Chapter 05 - Operating and Financial Leverage 35. The interwoven boundaries of banks and different trading companies in Japan make it easier to acquire credit in Japan than in the U.S. TRUE 36. For Japanese firms that have high levels of operating and financial leverage, maintaining sales volume is of critical importance even at the cost of price. TRUE 37. In order to conduct a cash break-even analysis, the analyst must add back depreciation from fixed costs. FALSE 38. An example of an adjustment for a cash break-even analysis would be adding back increases in accounts receivable. FALSE