Practice Questions for Finance Chapter 5

96. Follies Bookstore, the only bookstore close to campus, had net income in 2005 of $90,000. Here are some of the financial ratios from the annual report. Using these ratios, calculate the following for Follies Bookstore: a) Sales b) Total assets c) Total asset turnover d) Total debt e) Stockholders' equity f) Return on equity Chapter 5 97. Leverage is the use of fixed costs to magnify returns at high levels of operation. TRUE 98. Leverage works best when volume is increasing. TRUE 99. Operating leverage emphasizes the impact of using fixed assets in the business. TRUE 100. Financial leverage emphasizes the impact of using debt in the business. TRUE 101. Sales commissions and raw material are variable costs. TRUE 102. The contribution margin is equal to price per unit minus total costs per unit. FALSE 103. As the contribution margin rises, the breakeven point goes down. TRUE 104. Linear break-even analysis assumes that costs are linear functions of volume. TRUE 105. Linear breakeven analysis and operating leverage are only valid within a relevant range of production. TRUE 106. Financial leverage primarily affects the left-hand side of the balance sheet. FALSE 107. 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 108. The degree of financial leverage measures the percentage change in EPS for every 1 percent move in EBIT. TRUE 109. Operating leverage influences the bottom half of the income statement while financial leverage deals with the top half. FALSE 110. Firms with cyclical sales should employ a high degree of leverage. FALSE 111. 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 112. An example of an adjustment for a cash break-even analysis would be adding back increases in accounts receivable. FALSE 113. Degree of combined leverage considers the impact of a change in volume on the change in operating income. FALSE 114. The concept of operating leverage involves the use of __________ to magnify returns at high levels of operation. A. fixed costs B. variable costs C. marginal costs D. semi-variable costs 115. Which of the following questions does break-even analysis attempt to address? A. How much do changes in volume effect costs and profits? B. At what point does the firm break even? C. What is the most efficient level of fixed assets to employ? D. All of these 116. In break-even analysis, the contribution margin is defined as A. price minus variable cost. B. price minus fixed cost. C. variable cost minus fixed cost. D. fixed cost minus variable cost. 117. At the break-even point, a firm's profits are A. greater than zero. B. less than zero. C. equal to zero. D. Not enough information to tell 118. If a firm has a break-even point of 20,000 units and the contribution margin on the firm's single product is $3.00 per unit and fixed costs are $60,000, what will the firm's net income be at sales of 30,000 units? A. $90,000 B. $30,000 C. $15,000 D. $45,000 119. If sales volume exceeds the break-even point, the firm will experience A. an operating loss. B. an operating profit. C. an increase in plant and equipment. D. an increase in stock price. 120. The break-even point can be calculated as A. variable costs divided by contribution margin. B. total costs divided by contribution margin. C. variable cost times contribution margin. D. fixed cost divided by contribution margin. 121. A highly automated plant would generally have A. more variable than fixed costs. B. more fixed than variable costs. C. all fixed costs. D. all variable costs. 122. If fixed costs rise while other variables stay constant A. the breakeven point rises. B. degree of operating leverage increases. C. total profit declines. D. all of these 123. If the price per unit decreases because of competition but the cost structure remains the same A. the breakeven point rises. B. the degree of combined leverage declines. C. the degree of financial leverage declines. D. All of these 124. If a firm has fixed costs of $30,000, a price of $4.00, and a breakeven point of 15,000 units, the variable cost per unit is: A. $5.00 B. $2.00 C. $.50 D. $4.00 125. If a firm has fixed costs of $20,000, variable cost per unit of $.50, and a breakeven point of 5,000 units, the price is: A. $2.50 B. $5.00 C. $4.00 D. $4.50 126. If a firm has a price of $4.00, variable cost per unit of $2.50 and a breakeven point of 20,000 units, fixed costs are equal to: A. $13,333 B. $10,000 C. $30,000 D. $50,000 127. A firm with $50,000 in fixed costs breaks even on unit sales of 10,000, how many units must the firm sell to earn $20,000 in operating profits? A. 12,000 units B. 14,000 units C. 16,000 units D. There is not enough information to determine the unit sales required. 128. A firm has operating profits of $10,000 on unit sales of 5,000 units. Fixed costs are $30,000. What is the firm's break-even sales level? A. less than 4000 units. B. 4000 units. C. more than 4000 units D. There is not enough information to determine the unit break-even point. 129. A firm's break-even point will rise if A. fixed costs decrease B. contribution margins increase C. price per unit rises D. variable cost per unit rises 130. Davison Toaster Corp. sells its products for $100 per unit. It has the following costs: The break-even point is A. less than 2500 units B. 2500 units C. more than 2500 units D. not enough information has been provided to determine the break-even point. 131. Which of the following is true about the concept of leverage? A. at the breakeven point, operating leverage is equal to zero. B. combined leverage measures the impact of operating and financial leverage on EBIT. C. financial leverage measures the impact of fixed costs on earnings. D. none of these 132. A weakness of breakeven analysis is that it assumes: A. revenue and costs are a linear (constant) function of volume. B. prices and costs increase when the economy is strong and confidence is high. C. cost of goods sold goes up as revenue increases. D. there is no weakness. 133. A high DOL means: A. there are high labor costs. B. there is high debt. C. there is a large amount of equity. D. there are high fixed costs. 134. Which of the following is concerned with the change in operating profit as a result of a change in volume? A. Financial leverage B. Break-even point C. Operating leverage D. Combined leverage 135. Cash breakeven analysis A. is helpful in analyzing the short-term outlook of the firm, particularly when it is in trouble financially. B. is important when analyzing long-term profitability. C. includes depreciation expense as a fixed cost when calculating the degree of financial leverage. D. None of these. 136. The degree of operating leverage may be defined as A. the percent change in operating income divided by the percent change in unit volume. B. Q (P-VC) divided by Q (P-VC) - FC. C. S - TVC divided by S - TVC - FC. D. all of these 137. Loretta & Nieces fixed costs are $200,000, including $20,000 of depreciation expense. The price of each unit sold is $12, and the variable cost per unit is $6. How many units must the firm sell to reach the cash break-even point? A. less than 33,333 units B. 33,333 units C. More than 33,333 units D. not enough information has been provided to determine the cash break-even point 138. Conservatively leveraged Firm C and highly leveraged Firm H operate at the same level of earnings before interest and taxes where the return on assets is greater than the cost of debt. A. Firm C will have a higher return on equity than H. B. Firm H will have a higher return on equity than C. C. The return on equity will not be affected by financial leverage. D. The return on equity will be the same at an equal level of earnings. 139. The degree of operating leverage is computed as A. percent change in operating profit divided by percent change in net income. B. percent change in volume divided by percent change in operating profit. C. percent change in EPS divided by percent change in operating income. D. percent change in operating income divided by percent change in volume. 140. Firm A employs a high degree of operating leverage; Firm B takes a more conservative approach. 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 the same rate for both companies after the breakeven point. 141. Firms with a high degree of operating leverage are A. easily capable of surviving large changes in sales volume B. usually trading off lower levels of risk for higher profits. C. significantly affected by changes in interest rates. D. trading off higher fixed costs for lower per-unit variable costs. 142. Financial leverage deals with: A. the relationship of fixed and variable costs. B. the relationship of debt and equity in the capital structure. C. the entire income statement. D. the entire balance sheet. 143. A conservative financing plan involves A. heavy reliance on debt. B. heavy reliance on equity. C. high degree of financial leverage. D. high degree of combined leverage. 144. A firm's earnings per share is not impacted by its financing plan at the point when A. debt is equal to equity. B. return on assets equals return on equity. C. the cost of borrowed funds equals the return on equity. D. the cost of borrowed funds equals the return on assets. 145. If EBIT equals $160,000 and interest equals $30,000, what is the degree of financial leverage? A. 5.33x B. 1.23x C. .8125x D. 4.33x 146. The degree of financial leverage is concerned with the relation between A. changes in volume and changes in EPS. B. changes in volume and changes in EBIT. C. changes in EBIT and changes in EPS. D. changes in EBIT and changes in operating income. 147. When a firm employs no debt A. it has a financial leverage of one. B. it has a financial leverage of zero. C. its operating leverage is equal to its financial leverage. D. it will not be profitable. 148. If a firm has the lowest possible degree of operating leverage and the lowest possible degree of financial leverage, then A. DOL equals 1, and DFL equals 0. B. DOL equals 0, and DFL equals 1. C. DOL equals 1, and DFL equals 1. D. none of these 149. Combined leverage is concerned with the relationship between A. changes in EBIT and changes in EPS. B. changes in volume and changes in EPS. C. changes in volume and changes in EBIT. D. changes in EBIT and changes in net income. 150. Which of the following is not true about leverage? A. operating leverage influences the top half of the income statement, determining EBIT. B. financial leverage deals with the bottom half of the income statement, determining EPS C. combined leverage utilizes the entire income statement, showing the impact of change in volume on EBIT. D. none of these 151. If the business cycle were just beginning its upswing, which firm would you anticipate would be likely to show the best growth in EPS over the next year? Firm A has high combined leverage and Firm B has low combined leverage. A. Firm A B. Firm B C. Indifferent between the two D. It depends on how much financial leverage each firm has. 152. Refer to the figure above. The Degree of Operating Leverage is A. 1.43x B. 1.56x C. 3.33x D. 2.22x 153. Refer to the figure above. The Degree of Financial Leverage is A. 1.29x B. 4.50x C. 3.50x D. 1.32x 154. Refer to the figure above. The Degree of Combined Leverage is A. 2.2x B. 1.9x C. 2.9x D. 2.0x 155. Refer to the figure above. This firm's break-even point is A. 4,800 units B. 14,634 units C. 7,142 units D. 18,000 units 156. Refer to the figure above. The Degree of Operating Leverage (DOL) is A. 1.58x B. 1.95x C. 3.50x D. 1.40x 157. Refer to the figure above. The Degree of Financial Leverage (DFL) is A. 3.50x B. 1.40x C. 1.95x D. 1.58x 158. Refer to the figure above. The Degree of Combined Leverage (D.C.L.) is A. 3.08x B. 5.45x C. 2.73x D. 6.83x 159. 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. 160. 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 161. 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. 162. 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 163. If TechCor has fixed costs of $80,000, variable costs of $1.20/unit, sales price/unit of $6, and depreciation expense of $25,000, what is their cash breakeven in units? A. 9,167 B. 11,458 C. 21,875 D. 45,833 164. Green Co. has total assets $550,000, a cost of borrowed funds of 7%, and an EBIT of $41,250. 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 165. From the following income statement, calculate: a) Degree of financial leverage. b) Degree of operating leverage. c) Degree of combined leverage. 166. Heister Corporation produces class rings to sell to college and high school students. These rings sell for $75 each, and cost $35 each to produce. Heister has fixed costs of $50,000. a) Calculate Heister's break-even point. b) How much profit (loss) will Heister have if it sells 1,000 rings? 8,000 rings? c) Heister's president, J. R. D'Angelo, expects an annual profit of $100,000. How many rings must be sold to attain this profit? 167. A new restaurant is ready to open for business. It is estimated that the food cost (variable cost) will be 40% of sales, while fixed cost will be $450,000. The first year's sales estimates are $1,250,000. 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 12%, 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.