Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
Chapter 05 - Operating and Financial Leverage
1. Leverage is the use of fixed costs to magnify returns at high levels of operation.
2. Leverage works best when 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.
Chapter 05 - Operating and Financial Leverage
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
labor that it uses.
7. Contribution margin is equal to fixed costs minus variable costs.
8. Property Taxes and depreciation expense are examples of variable costs.
9. Sales commissions and raw material are variable costs.
Chapter 05 - Operating and Financial Leverage
10. The contribution margin is equal to price per unit minus total costs per unit.
11. As the contribution margin rises, the breakeven point goes down.
12. A lower price for the firm's product will reduce the firm's breakeven point.
13. If economic conditions were expected to be favorable, an investor would likely prefer a
firm with a low degree of leverage.
Chapter 05 - Operating and Financial Leverage
14. Use of financial leverage must consider risk, not just maximizing profit.
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.
16. Managers who are risk averse and uncertain about the future would most likely minimize
combined leverage.
17. Management should tailor the use of leverage to meet its own risk-taking desires.
Chapter 05 - Operating and Financial Leverage
18. Cash breakeven analysis eliminates the depreciation expense and other non-cash charges
from fixed costs.
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.
20. The closer a firm is to its break-even point, the lower the degree of operating leverage will
be.
21. Degree of operating leverage should be computed only over a profitable range of
operations.
Chapter 05 - Operating and Financial Leverage
22. Linear break-even analysis assumes that costs are linear functions of volume.
23. Linear breakeven analysis and operating leverage are only valid within a relevant range of
production.
24. Financial leverage primarily affects the left-hand side of the balance sheet.
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.
Chapter 05 - Operating and Financial Leverage
26. The degree of financial leverage measures the percentage change in EPS for every 1
percent move in EBIT.
27. If a firm has a DFL of 2.0, EPS will change 2% for every 1% change in volume.
28. The degree of financial leverage is not influenced by the interest rate on debt, only the
amount borrowed.
29. A firm with a high degree of financial leverage could face financial difficulty even though
it is in a stable industry.
Chapter 05 - Operating and Financial Leverage
30. Operating income is not the same thing as EBIT.
31. Operating leverage influences the bottom half of the income statement while financial
leverage deals with the top half.
32. The degree of combined leverage is the sum of the degree of operating leverage and the
degree of financial leverage.
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.
Chapter 05 - Operating and Financial Leverage
34. Firms with cyclical sales should employ a high degree of 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.
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.
37. In order to conduct a cash break-even analysis, the analyst must add back depreciation
from fixed costs.
Chapter 05 - Operating and Financial Leverage
38. An example of an adjustment for a cash break-even analysis would be adding back
increases in accounts receivable.
39. Degree of combined leverage considers the impact of a change in volume on the change in
operating income.
40. Financial leverage breakeven occurs when return on total assets is equal to the cost of
borrowed funds.
41. Increasing financial leverage will always lead to higher EPS because it reduces the
number of shares outstanding.
Chapter 05 - Operating and Financial Leverage
42. The concept of operating leverage involves the use of __________ to magnify returns at
high levels of operation.
43. Which of the following questions does break-even analysis attempt to address?
44. In break-even analysis, the contribution margin is defined as
Chapter 05 - Operating and Financial Leverage
45. At the break-even point, a firm's profits are
46. If a firm has a break-even point of 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 sales of 30,000 units?
47. If sales volume exceeds the break-even point, the firm will experience
Chapter 05 - Operating and Financial Leverage
48. The break-even point can be calculated as
49. A highly automated plant would generally have
50. If fixed costs rise while other variables stay constant
Chapter 05 - Operating and Financial Leverage
51. If the price per unit decreases because of competition but the cost structure remains the
same
52. If a firm has fixed costs of $60,000, a price of $7.00, and a breakeven point of 25,000
units, the variable cost per unit is:
Chapter 05 - Operating and Financial Leverage
53. If a firm has fixed costs of $30,000, variable cost per unit of $.75, and a breakeven point
of 5,000 units, the price is:
54. If a firm has a price of $6.00, variable cost per unit of $4.00 and a breakeven point of
40,000 units, fixed costs are equal to:
55. A firm with $49,000 in fixed costs breaks even on unit sales of 7,000, how many units
must the firm sell to earn $30,000 in operating profits?
Chapter 05 - Operating and Financial Leverage
56. A firm has operating profits of $15,000 on unit sales of 10,000 units. Fixed costs are
$30,000. What is the firm's break-even sales level?
57. A firm's break-even point will rise if
Chapter 05 - Operating and Financial Leverage
58. Davison Toaster Corp. sells its products for $150 per unit. It has the following costs:
The break-even point is
59. Which of the following is true about the concept of leverage?
Chapter 05 - Operating and Financial Leverage
60. A weakness of breakeven analysis is that it assumes:
61. A high DOL means:
62. Which of the following is concerned with the change in operating profit as a result of a
change in volume?
