Chapter 05 Test Bank – Static Key
1. “Operating leverage” is the use of fixed costs to magnify returns at high levels of operation.
2. Operating leverage works best when product volume is increasing.
3. Operating leverage emphasizes the impact of using fixed assets in the business.
4. Financial leverage emphasizes the impact of using debt in the business.
5. Operating leverage determines how income from operations is to be divided between debt holders and
stockholders.
6. Operating leverage will change when a firm alters the mix of fixed capital resources and variable labor
05-2
7. Contribution margin is equal to fixed costs minus variable costs.
8. Contribution margin represents the amount of sales left over after fixed costs are paid.
9. Property taxes and depreciation expense are examples of variable costs.
10. Sales commissions and raw materials are variable costs.
11. The difference between variable cost and fixed cost is that the cost amount fluctuates differently based
on how many uses are sold.
12. The contribution margin is equal to sales price per unit minus total costs per unit.
13. As the contribution margin rises, the break-even point goes down.
05-3
14. Break-even analysis helps a company determine what amount of quantity it needs to sell in order to
reach zero profit.
15. A lower sales price for the firm’s product will reduce the firm’s break-even point.
16. If economic conditions were expected to be favorable, an investor would likely prefer a firm with a low
degree of leverage.
17. The use of financial leverage must consider both risk and maximizing profit.
18. The use of debt is not typically needed for firms in industries that offer some degree of stability, are in a
positive stage of growth, and are operating in favorable economic conditions.
19. Managers who are risk-averse and uncertain about the future would most likely minimize combined
leverage.
20. Management should tailor the use of leverage to meet the company’s own risk-taking desires.
21. Cash break-even analysis eliminates the non-cash charges from fixed costs in order to obtain the
amount of quantity sold is necessary in order for cash inflow to equal the cash outflow.
22. 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.
23. The lower a firm’s break-even point, the lower amount of quantity needs to be sold in order to reach a
profit of zero.
24. The lower a firm’s break-even point, the better for the firm.
25. The closer a firm is to its break-even point, the lower the degree of operating leverage it will be.
26. Degree of operating leverage should be computed only over a profitable range of business operations.
27. Linear break-even analysis assumes that the change in costs have the same relationship with the
change in volume.
28. Linear break-even analysis and operating leverage are only valid within a relevant range of unit
production.
29. Financial leverage primarily affects the asset side of the balance sheet.
30. Operating leverage primarily affects the asset side of the balance sheet, while financial leverage affects
31. The degree of financial leverage measures the percentage change in earnings per share (EPS) for
every percentage change in earnings before interest and taxes (EBIT).
32. If a firm has a degree of financial leverage (DFL) of 2.0, earnings per share will change 2% for every
1% change in sales volume.
33. The degree of financial leverage is not influenced by the interest rate on debt, only the amount
borrowed.
34. A firm with a high degree of financial leverage could face financial difficulty even though it is in a stable
industry.
35. Operating income is not the same thing as earnings before interest and taxes (EBIT).
36. Operating leverage influences the bottom half of the income statement while financial leverage deals
with the top half.
38. 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.
39. Firms with cyclical sales should employ a high degree of leverage.
40. In order to conduct a cash break-even analysis, the analyst must add back depreciation from fixed
costs.
41. An example of an adjustment for a cash break-even analysis would be adding back increases in
accounts receivable.
42. Degree of combined leverage considers the impact of a change in volume on the change in operating
income.
43. Reducing the number of outstanding shares will always increase financial leverage since earnings per
share will be higher, all else stays the same.
44. The concept of operating leverage involves the use of __________ to magnify returns at high levels of
operation.
45. Which of the following questions does break-even analysis attempt to address?
46. In break-even analysis, the contribution margin is defined as
47. At the break-even point, a firm’s profits are
48. If a firm sells 40,000 units and the contribution margin on the firm’s single product is $4.00 per unit and
fixed costs are $60,000, what will the firm’s operating profit be at this level of sales volume?
49. If a firm sells 40,000 units and the contribution margin on the firm’s single product is $4.00 per unit and
fixed costs are $60,000, what is the firm’s breakeven point in units?
50. If sales units exceeds the break-even point in units, the firm will experience
51. The break-even point can be calculated as
52. A highly automated plant would generally have
53. If fixed costs rise while other variables stay constant
54. If the sales price per unit decreases because of competition but the cost structure remains the same
55. If a firm has fixed costs of $60,000, a sales price of $7.00 per unit, and a break-even point of 25,000
units, the variable cost per unit is _____.
56. If a firm has fixed costs of $85,000, a variable cost per unit of $10 and sales price per unit of $15, what
is the firm’s breakeven point in units?
57. If a firm has fixed costs of $30,000, a variable cost per unit of $.75, and a break-even point of 5,000
units, the sales price per unit is _____.
58. If a firm has a sales price per unit of $6.00, a variable cost per unit of $4.00, and a break-even point of
40,000 units, fixed costs are equal to _____.
59. If a firm with $49,000 in fixed costs breaks even on 7,000 units, how many units must the firm sell to
earn $30,000 in operating profit?
60. A firm has operating profit of $15,000 on unit sales of 10,000 units. Fixed costs are $30,000. What is
the firm’s break-even in units?
61. A firm’s break-even point will rise if
62. Davison Toaster Corp. sells its products for $150 per unit. It has the following costs: