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Chapter 17 – Financial Planning and Control
69. If a firm’s degree of total leverage (DTL) is 8.0, which of the following must be correct?
a. The firm must have fixed operating costs.
b. The firm must have fixed financial costs.
c. The firm must have both fixed operating costs and fixed financial costs.
d. The firm must have some fixed costs, but not enough information is given to determine whether the fixed
costs are operating, financial, or both.
e. With the information given, we cannot tell whether the firm has any fixed costs (either operating or financial)
at all.
70. All else equal, one firm will have a lower breakeven point than another firm if
a. its fixed costs are higher.
b. its selling price of the product is higher.
c. its variable operating cost per unit is higher.
d. All of the above.
e. None of the above.
71. Everything else equal, a firm can reduce its operating breakeven point by
a. increasing its fixed costs.
b. decreasing the selling price of the product that is sold.
c. increasing the contribution margin, which is the product’s selling price less its variable cost.
d. increasing the variable cost per unit.
e. None of the above is correct.
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Chapter 17 – Financial Planning and Control
72. If a firm has a degree of operating leverage (DOL) that is greater than 1.0, the we know that a 1.0 percent change
in will cause in a change in that is 1.0 percent.
a. EBIT; sales; greater than
b. EBIT; net income; greater than
c. sales; EBIT; less than
d. sales; EBIT; greater than
e. EBIT; net income; less than
73. Business risk is related with the operations of the firm. Which of the following is not directly associated with, that is,
not a part of, business risk?
a. product demand variability
b. sales price variability
c. relative amount of fixed operating costs
d. degree of price flexibility with respect to changes in operating costs
e. changes in required returns due to financing decisions
74. Everything else equal, if a firm shifts its capital structure to include more debt than before the shift, then the firm‘s
business risk should
a. increase because the degree of financial leverage increases.
b. decrease because the degree of operating leverage decreases.
c. not change because capital structure decisions should affect the firm‘s financial risk, not its business risk.
d. not change because, although additional common stock will increase financial risk, the business risk should
decrease by the same amount.
e. increase because the degree of financial leverage increases.
75. Which of the following statements is correct?
a. The first pass using the projected balance sheet method determines the financing feedback effects and
determines how much in additional funds are needed. The second pass completes the cycle, identifies the full
financing need, and eliminates further feedback effects.
b. Interest expense on additional new debt is the only income statement account affected by financing feedback,
and dividends payable to new common stock is the only balance sheet account affected.
c. The projected balance sheet method is useful for determining additional funds needed, however, it cannot be
used in evaluating dividend policy and capital structure decisions.
d. One reason a firm’s managers may choose to meet additional funds needed requirements through common
stock is that it involves no financing feedback effects. Since no new debt is used, interest expense will be
considered fully in the first pass, the income statement will remain unchanged, and no second pass is needed.
e. If new debt and new stock are used to meet new financing needs, net income will decrease from the first
pass to the second pass even though taxes decrease. In addition, if dividends are to be paid on new stock, this
will further decrease the amount of retained earnings available for financing needs.
76. For a particular product, Sandbarr Corporation has operating fixed costs of $30,000, of which depreciation of $15,000
is the only non–cash outlay. The unit sale price is $4.20 per unit and variable costs are $2.20 per unit. What is the
operating financial breakeven point in units for Sandbarr?
a. 3,572 units
b. 6,818 units
c. 10,000 units
d. 15,000 units
e. 7,500 units
77. The Price Company will produce 55,000 widgets next year. Variable costs will equal 40 percent of sales, while
operating fixed costs will total $110,000. At what price must each widget be sold for the company to achieve an
EBIT of $95,000?
a. $2.00
b. $4.45
c. $5.00
d. $5.37
e. $6.21
78. You are the owner of a small business which has the following balance sheet:
Current assets
$ 5,000
Accounts payable
$ 1,000
Net fixed assets
10,000
Accruals
1,000
Long-term debt
5,000
______
Common equity
8,000
Total assets
$15,000
Total
$15,000
Fixed and current assets are fully utilized, and the sales/assets and sales/spontaneous liabilities ratios will remain
constant. Next year you expect sales to increase by 50 percent. You also expect to retain $2,000 of next year’s
earnings within the firm. What is next year’s additional external funding requirement, i.e., what is your firm’s AFN?
a. No additional funds are required.
b. $3,500
c. $4,500
d. $5,500
e. The answer depends on this year’s sales level.
79. A firm has the following balance sheet:
Cash
$ 10
Accounts payable
$ 10
Accounts receivable
10
Notes payable
20
Inventories
10
Long-term debt
40
Fixed assets
90
Common stock
40
____
Retained earnings
10
Total assets
$120
Total liabilities and equity
$120
Fixed assets are being used at 80 percent of capacity; sales for the year just ended were $200; sales will increase
$10 per year for the next 4 years; the profit margin is 5 percent; and the dividend payout ratio is 60 percent. Assume
that fixed assets cannot be sold. What are the total external financing requirements for the entire 4 years, i.e., the
total AFN for the 4-year period?
a. $4.00
b. $2.00
c. −$0.80 (Surplus)
d. −$14.00 (Surplus)
e. $0
80. Compuvac Company has just completed its first pass forecast using the projected balance sheet method. The firm
has determined that it needs $4 million in new debt which can be sold at par with a 10% annual coupon. Additionally,
the firm will sell 500,000 shares of new common equity at $18.10 per share. Next year’s expected dividend is $0.48
per share. The firm expects that taxes will be $160,000 less under the second pass than they were under the first
pass based on a 40% tax rate. Given this information, what is the incremental change in AFN for Compuvac going
from the first pass to the second pass?
a. $240,000
b. $0
c. $480,000
d. $160,000
e. $640,000
81. Martin Corporation currently sells 180,000 units per year at a price of $7.00 per unit; its variable cost is $4.20 per
unit; and fixed operating costs are $400,000. Martin is considering expanding into two additional states which would
increase its fixed costs to $650,000 and would increase its variable unit cost to an average of $4.48 per unit. If
Martin expands it expects to sell 270,000 units at $7.00 per unit. By how much will Martin’s operating breakeven
sales dollar level change?
a. $183,333
b. $456,500
c. $805,556
d. $910,667
e. $1,200,000
82. Marcus Corporation currently sells 150,000 units a year at a price of $4.00 a unit. Its variable costs are
approximately 30% of sales, and its fixed operating costs amount to 50% of revenues at its current output level.
Although fixed costs are based on revenues at the current output level, the cost level is fixed. What is Marcus’
degree of operating leverage in sales dollars?
a. 1.0
b. 2.2
c. 3.5
d. 4.0
e. 5.0
83. Musgrave Corporation has fixed operating costs of $46,000 and variable costs that are 30% of the current sales
price of $2.15. At a price of $2.15, Musgrave sells 40,000 units. Musgrave can increase sales by 10,000 units by
cutting its unit price from $2.15 to $1.95, but variable cost per unit won’t change. Should it cut its price?
a. No, EBIT decreases by $6,000.
b. No, EBIT decreases by $250.
c. Yes, EBIT increases by $11,500.
d. Yes, EBIT increases by $8,050.
e. Yes, EBIT increases by $5,050.
84. Carolina Vineyards is considering two alternative production methods for turning grapes into wine. One method calls
for using a hand-operated press, while the other would employ a new, automated press. It has been estimated that
the variable cost per bottle will amount to $2.00 using the old press and $0.50 using the new machine. If the new
machine is purchased, fixed operating costs will equal $150,000, and interest charges will be $80,000. Fixed operating
costs of $25,000 will be incurred if the company decides to use the old press, and interest costs will be zero because
no debt will be needed. Assume that sales (in units) will be 100,000 bottles under the automated method and 75,000
units under the labor intensive method. What sales price per unit would cause Carolina to be indifferent between the
two methods?
a. $2.00
b. $2.20
c. $4.00
d. $4.20
e. $6.00
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Chapter 17 – Financial Planning and Control
85. Refer to Crum Company. Crum expects sales to grow by 50% in 2010, and operating costs should increase at the
same rate. Fixed assets were being operated at 40% of capacity in 2009, but all other assets were used to full
capacity. Underutilized fixed assets cannot be sold. Current assets and spontaneous liabilities should increase at the
same rate as sales during 2010. The company plans to finance any external funds needed as 35% notes payable and
65% common stock. After taking financing feedbacks into account, and after the second pass, what is Crum’s
projected ROE using the projected balance sheet method?
a. 16.98%
b. 23.73%
c. 25.68%
d. 19.61%
e. 23.24%
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Chapter 17 – Financial Planning and Control
86. Hogan Inc. generated EBIT of $240,000 this past year using assets of $1,100,000. The interest rate on its existing
long–term debt of $640,000 is 12.5 percent and the firm’s tax rate is 40 percent. The firm paid a dividend of $1.27 on
each of its 37,800 shares outstanding from net income of $96,000. The total book value of equity is $446,364 of
which the common stock account equals $335,000. The firm’s shares sell for $28.00 per share in the market. The
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Chapter 17 – Financial Planning and Control
firm forecasts a 10% increase in sales, assets, and EBIT next year, and a dividend of $1.40 per share. If the firm
needs additional capital funds, it will raise 60% with debt and 40% with equity. The cost of any new debt will be
13%. Spontaneous liabilities are estimated at $15,000 for next year, representing an increase of 10% over this year.
Except for spontaneous liabilities, the firm uses no other sources of current liabilities and will continue this policy in
the future. What will be the cumulative AFN Hogan will need to balance its projected balance sheet using the
projected balance sheet method through the first two passes?
a. $5,013
b. $3,417
c. $51,156
d. $26,228
e. $54,573
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Chapter 17 – Financial Planning and Control
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Chapter 17 – Financial Planning and Control
Trident Food Corporation
Trident Food Corporation generated the following income statement for the most recent fiscal year, which ended
December 31, 2010:
Sales revenues
$150,000
Variable cost of sales
(112,500)
Gross profit
37,500
Fixed operating costs
(24,000)
Net operating income (EBIT)
13,500
Interest
(10,000)
Earnings before taxes
3,500
Taxes (40%)
(1,400)
Net income
2,100
Each item of inventory Trident Foods produces has a selling price of $20.
87. Refer to Trident Food Corporation. What is the degree of operating leverage for Trident Foods?
a. 2.78
b. 10.71
c. 3.86
d. 3.00
e. 4.00
88. Refer to Trident Food Corporation. What is the degree of total leverage for Trident Foods?
a. 42.86
b. 10.71
c. 71.43
d. 17.86
e. 6.43
89. Refer to Trident Food Corporation. What is the operating breakeven point in sales units (Q) for Trident Foods?
a. 7,500
b. 5,625
c. 6,825
d. 4,800
e. 2,700
90. Refer to Trident Food Corporation. What is the financial breakeven point for Trident Foods?
a. EBIT = $146,500
b. Sales = 4,800 units
c. EBIT = $10,000
d. Net income = $10,000
e. EBIT = $11,400
91. Refer to Trident Food Corporation. How many units of inventory must Trident Foods sell if it wants to operate at
its financial breakeven point?
a. 2,000
b. 500
c. 4,800
d. 2,280
e. 6,800