Chapter 05 – Operating and Financial Leverage
63. Cash breakeven analysis
64. The degree of operating leverage may be defined as
65. Loretta & Nieces fixed costs are $425,000, including $25,000 of depreciation expense.
The price of each unit sold is $120, and the variable cost per unit is $60. How many units
must the firm sell to reach the cash break-even point?
Chapter 05 – Operating and Financial Leverage
66. 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.
67. The degree of operating leverage is computed as
68. 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?
Chapter 05 – Operating and Financial Leverage
69. Firms with a high degree of operating leverage are
70. Financial leverage deals with:
71. A conservative financing plan involves
Chapter 05 – Operating and Financial Leverage
72. A firm’s earnings per share is not impacted by its financing plan at the point when
73. If EBIT equals $200,000 and interest equals $40,000, what is the degree of financial
leverage?
74. The degree of financial leverage is concerned with the relation between
Chapter 05 – Operating and Financial Leverage
75. When a firm employs no debt
76. If a firm has the lowest possible degree of operating leverage and the lowest possible
degree of financial leverage, then
77. Combined leverage is concerned with the relationship between
Chapter 05 – Operating and Financial Leverage
78. Which of the following is not true about leverage?
79. 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.
Chapter 05 – Operating and Financial Leverage
80. Refer to the figure above. The Degree of Operating Leverage is
81. Refer to the figure above. The Degree of Financial Leverage is
Chapter 05 – Operating and Financial Leverage
82. Refer to the figure above. The Degree of Combined Leverage is
Chapter 05 – Operating and Financial Leverage
83. Refer to the figure above. This firm’s break-even point is
84. Refer to the figure above. The Degree of Operating Leverage (DOL) is
Chapter 05 – Operating and Financial Leverage
85. Refer to the figure above. The Degree of Financial Leverage (DFL) is
86. Refer to the figure above. The Degree of Combined Leverage (D.C.L.) is
Chapter 05 – Operating and Financial Leverage
87. Heavy use of long-term debt may be beneficial in an inflationary economy because
88. Under which of the following conditions could the overuse of financial leverage be
detrimental to the firm?
89. 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?”
Chapter 05 – Operating and Financial Leverage
90. A factory which relies on highly technical machinery, may choose to reduce their overall
leverage position by
91. If TechCor has fixed costs of $60,000, variable costs of $1.20/unit, sales price/unit of $7,
and depreciation expense of $25,000, what is their cash breakeven in units?
Chapter 05 – Operating and Financial Leverage
92. Green Co. has total assets $400,000, a cost of borrowed funds of 6%, and an EBIT of
$42,500. From a financial breakeven perspective, Green Co. is
Chapter 05 – Operating and Financial Leverage
93. Match the following with the items below:
1. leverage (concept
A reflection of the extent fixed assets and fixed costs
2. break-even
The amount of fixed costs covered by each unit of
sales. This amount is derived by subtracting variable
3. degree of
4. degree of
A measure of the impact of fixed costs on earnings
5. nonlinear break-
A numerical and graphical technique used to
determine at what point the firm will equate its costs and
The use of fixed charge obligations with the intent of
magnifying the potential returns to the owners of the
7. contribution
A measure of the amount of debt used in the capital
Costs that remain relatively constant regardless of the
A measure of the impact of debt on the earnings
10. combined
11. degree of
The use of break-even analysis based on the
assumption that cost and revenue relationships to
12. operating
A measure of the total effect on earnings per share of
Chapter 05 – Operating and Financial Leverage
94. From the following income statement, calculate:
a) Degree of financial leverage.
b) Degree of operating leverage.
c) Degree of combined leverage.
Chapter 05 – Operating and Financial Leverage
95. Heister Corporation produces class rings to sell to college and high school students. These
rings sell for $75 each, and cost $30 each to produce. Heister has fixed costs of $45,000.
a) Calculate Heister’s break-even point.
b) How much profit (loss) will Heister have if it sells 800 rings? 6,000 rings?
c) Heister’s president, J. R. D’Angelo, expects an annual profit of $200,000. How many rings
must be sold to attain this profit?
Chapter 05 – Operating and Financial Leverage
5-36
96. A new restaurant is ready to open for business. It is estimated that the food cost (variable
cost) will be 30% of sales, while fixed cost will be $540,000. The first year’s sales estimates
are $1,500,000. 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 9%, 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.
Chapter 05 – Operating and Financial Leverage