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BSA 36P FM II (LONG-TERM) > CH13 TB LEVERAGE AND CAPITAL STRUCTURE > Flashcards

CH13 TB LEVERAGE AND CAPITAL STRUCTURE Flashcards

1
Q

Generally, increases in leverage result in increased return and risk.

T or F?

A

TRUE

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2
Q

Generally, decreases in leverage result in increased return and risk, whereas increases in leverage result in decreased return and risk.

T or F?

A

FALSE

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3
Q

Total leverage can be defined as the potential use of fixed costs, both operating and financial, to magnify the effect of changes in sales on a firm’s earnings per share.

T or F?

A

TRUE

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4
Q

Leverage results from the use of equity to magnify returns to a firm’s owners.

T or F?

A

FALSE

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5
Q

Operating leverage is concerned with the relationship between a firm’s sales revenue and its financial expenses.

T or F?

A

FALSE

operating expenses

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6
Q

Financial leverage is concerned with the relationship between a firm’s earnings after interest and taxes and its common stock earnings per share.

T or F?

A

FALSE

EBIT

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7
Q

Total leverage is concerned with the relationship between a firm’s sales revenue and its common stock earnings per share.

T or F?

A

TRUE

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8
Q

A firm’s capital structure is the mix of the current liabilities, long-term debt, and equity maintained by the firm.

T or F?

A

FALSE

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9
Q

The levels of fixed-cost assets and funds that management selects affect the variability of returns.

T or F?

A

TRUE

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10
Q

The amount of leverage in a firm’s capital structure—the mix of long-term debt and equity maintained by the firm—can significantly affect its value by affecting return and risk.

T or F?

A

TRUE

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11
Q

Both operating and financial leverage result in the magnification of return as well as risk.

T or F?

A

TRUE

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12
Q

While operating leverage results only in a magnification of returns, financial leverage results only in a magnification of risk.

T or F?

A

FALSE

High risk, high return

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13
Q

The dollar breakeven sales level can be solved for by dividing fixed costs by the contribution margin ratio.

T or F?

A

TRUE

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14
Q

The dollar breakeven sales level can be solved for by dividing fixed costs by the dollar contribution margin.

T or F?

A

FALSE

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15
Q

Breakeven analysis is used by a firm to determine the level of operations necessary to cover all fixed operating costs and to evaluate the profitability associated with various levels of production.

T or F?

A

FALSE

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16
Q

A firm’s operating breakeven point is the level of sales necessary to cover all fixed operating costs.

T or F?

A

FALSE

fixed and variable operating costs

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17
Q

In finding the operating breakeven point, it is important to divide the cost of goods sold and operating expenses into fixed and variable operating costs.

T or F?

A

TRUE

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18
Q

At the operating breakeven point, the sales revenue is equal to the sum of the fixed and variable operating costs.

T or F?

A

TRUE

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19
Q

Earnings before interest and taxes are positive above the operating breakeven point, and a loss occurs below it.

T or F?

A

TRUE

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20
Q

For sales levels below the operating breakeven point, sales revenue exceeds total operating costs, and earnings before interest and taxes is greater than zero.

T or F?

A

FALSE

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21
Q

An increase in cost (fixed cost or variable cost) tends to increase the operating breakeven point, whereas an increase in the sales price per unit will decrease the operating breakeven point.

T or F?

A

TRUE

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22
Q

The use of a dollar breakeven point is important when a firm has more than one product, especially when each product is selling at a different price.

T or F?

A

TRUE

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23
Q

The contribution margin is defined as the percent of each sales dollar that remains after satisfying fixed operating costs.

T or F?

A

FALSE

variable operating costs

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24
Q

The breakeven point in dollars can be computed by dividing the contribution margin into the variable operating costs.

T or F?

A

FALSE

FC/CM ratio

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25
Q

Due to the difficulty of allocating costs to products in a multiproduct firm, the breakeven model may fail to determine breakeven points for each product line.

T or F?

A

TRUE

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26
Q

Since the sales price per unit generally decreases with volume and the cost per unit generally increases with volume, the true breakeven point may be different from those obtained using linear revenue and cost functions as assumed in the breakeven analysis.

T or F?

A

TRUE

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27
Q

One of the limitations of breakeven analysis is its short-term time horizon. A large outlay in the current financial period could significantly raise the firm’s breakeven point, while the benefits may occur over a period of years.

T or F?

A

TRUE

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28
Q

The operating breakeven point can be found by solving for the sales level that just covers total fixed and variable costs.

T or F?

A

TRUE

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29
Q

Which of the following is true of leverage?
A) It refers to the effects that operating and financial fixed costs have on the returns that shareholders earn.
B) It is associated with risks which are out of the control of managers.
C) It includes the effect of operating fixed costs on the returns of shareholders and not the financial fixed costs.
D) It is used to evaluate the profitability associated with various levels of sales.

A

A

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30
Q

________ results from the use of fixed-cost assets or funds to magnify returns to a firm’s owners.
A) Long-term debt
B) Equity
C) Leverage
D) Capital structure

A

C

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31
Q

The three basic types of leverage are ________.
A) operating, production, and financial
B) operating, production, and total
C) production, financial, and total
D) operating, financial, and total

A

D

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32
Q

Generally, increases in leverage result in ________ return and ________ risk.
A) decreased; increased
B) decreased; decreased
C) increased; increased
D) increased; decreased

A

C

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33
Q

________ refers to the effects that fixed costs have on the returns that shareholders earn.
A) Purchase power parity
B) Leverage
C) Business risk
D) Pecking order theory

A

B

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34
Q

________ analysis is a technique used to assess the returns associated with various cost structures and levels of sales.
A) Time-series
B) Marginal
C) Breakeven
D) Ratio

A

C

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35
Q

Earnings before interest and taxes (EBIT) is a descriptive label for ________.
A) operating profits
B) net profits before taxes
C) earnings per share
D) gross profits

A

A

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36
Q

________ costs are a function of time, not sales, and are typically contractual.
A) Fixed
B) Semi-variable
C) Variable
D) Operating

A

A

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37
Q

In case of a manufacturing organization, which of the following is a variable cost that varies directly with the sales volume?
A) interest cost
B) dividend cost
C) shipping cost
D) rental cost

A

C

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38
Q

A firm’s ________ is the level of sales necessary to cover all operating costs, i.e., the point at which EBIT equals zero.
A) cash breakeven point
B) financial breakeven point
C) operating breakeven point
D) total breakeven point

A

C

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39
Q

Which of the following is a fixed cost?
A) inventory
B) rent
C) delivery costs
D) direct labor

A

B

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40
Q

________ costs require the payment of a specified amount in each accounting period.
A) Operating
B) Variable
C) Semi-variable
D) Fixed

A

D

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41
Q

At the operating breakeven point, ________ equals zero.
A) sales revenue
B) fixed operating costs
C) variable operating costs
D) earnings before interest and taxes

A

D

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42
Q

Breakeven analysis is used by a firm ________.
A) to determine the level of operations necessary to cover all fixed operating costs
B) to determine the least cost of producing goods and services
C) to evaluate the profitability associated with various levels of sales
D) to determine the demand of a product

A

C

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43
Q

If a firm’s fixed operating costs decrease, the firm’s ________.
A) operating breakeven point will decrease
B) operating breakeven point will increase
C) sale price per unit will decrease
D) sale price per unit will increase

A

A

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44
Q

If a firm’s variable costs per unit increase,the firm’s ________.
A) financial breakeven point will decrease
B) operating breakeven point will increase
C) sale price per unit will decrease
D) fixed costs per unit will increase

A

B

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45
Q

If a firm’s variable costs per unit increase,the firm’s ________.
A) financial breakeven point will decrease
B) operating breakeven point will increase
C) sale price per unit will decrease
D) fixed costs per unit will increase

A

B

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46
Q

If a firm’s fixed financial costs decrease, the firm’s operating breakeven point will ________.
A) decrease
B) increase
C) remain unchanged
D) change based on the sale price per unit

A

C

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47
Q

A firm’s operating breakeven point is the point at which ________.
A) total operating costs equal total fixed costs
B) total operating costs are zero
C) EBIT is less than sales
D) EBIT is zero

A

D

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48
Q

A major assumption of breakeven analysis and one which causes severe limitations in its use is that ________.
A) fixed costs really are fixed
B) total revenue is nonlinear
C) revenues and operating costs are linear
D) all costs are really semi-variable

A

C

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49
Q

________ is 100 percent minus total variable operating costs as a percentage of total sales.
A) Profit margin
B) Contribution margin
C) Expense ratio
D) Fixed coverage ratio

A

B

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50
Q

One function of breakeven analysis is to ________.
A) determine the profit attributable to each stockholder
B) evaluate the effect of leverage on a firm’s risks and returns
C) evaluate the profitability of various sales levels
D) determine the amount of financing needed by the firm

A

C

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51
Q

The preferred approach to breakeven analysis for a multiproduct firm is the ________.
A) breakeven point expressed in units
B) breakeven point expressed in dollars
C) cash breakeven point
D) overall breakeven point

A

B

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52
Q

Operating leverage is defined as the use of fixed operating costs to magnify the effects of changes in sales on a firm’s earnings before interest and taxes.

T or F?

A

TRUE

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53
Q

The degree of operating leverage will increase if a firm decides to compensate its sales representatives with a fixed salary and bonus rather than with a pure percent-of-sales commission.

T or F?

A

TRUE

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54
Q

Comparison of the degree of operating leverage of two firms is valid only when the base level of sales used for each firm is the same.

T or F?

A

TRUE

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55
Q

The degree of operating leverage depends on the base level of sales used as a point of reference. The closer the base sales level used is to the operating breakeven point, the greater the operating leverage.

T or F?

A

TRUE

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56
Q

Operating leverage results from the existence of operating costs in a firm’s income stream.

T or F?

A

FALSE

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57
Q

Operating leverage may be defined as the potential use of fixed operating costs to magnify the effects of changes in sales on a firm’s earnings before interest and taxes (EBIT).

T or F?

A

TRUE

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58
Q

Operating leverage is present when a firm has fixed operating costs.

T or F?

A

TRUE

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59
Q

Whenever the percentage change in earnings before interest and taxes resulting from a given percentage change in sales is greater than the percentage change in sales, operating leverage exists.

T or F?

A

TRUE

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60
Q

When a firm has fixed operating costs, operating leverage is present. In that case, an increase in sales results in a more-than-proportional increase in EBIT, and a decrease in sales results in a more-than- proportional decrease in EBIT.

T or F?

A

TRUE

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61
Q

Whenever the percentage change in EBIT resulting from a given percentage change in sales is greater than the percentage change in sales, operating leverage exists.

T or F?

A

TRUE

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62
Q

The closer the base sales level used is to the operating breakeven point, the smaller the operating leverage.

T or F?

A

FALSE

bigger

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63
Q

The base level of EBIT must be held constant to compare the financial leverage associated with different levels of fixed financial costs.

T or F?

A

TRUE

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64
Q

The effect of financial leverage is such that an increase in a firm’s earnings before interest and taxes (EBIT) results in a more than proportional increase in the firm’s earnings per share (EPS), while a decrease in the firm’s EBIT results in a less than proportional decrease in EPS.

T or F?

A

FALSE

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65
Q

Whenever the percentage change in earnings per share (EPS) resulting from a given percentage change in sales is greater than the percentage change in sales, financial leverage exists.

T or F?

A

FALSE

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66
Q

Financial leverage results from the presence of variable financial costs in a firm’s income stream.

T or F?

A

FALSE

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67
Q

Financial leverage may be defined as the potential use of variable financial costs to magnify the effects of changes in earnings before interest and taxes (EBIT) on a firm’s earnings per share (EPS).

T or F?

A

FALSE

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68
Q

The relationship between operating and financial leverage is additive rather than multiplicative.

T or F?

A

FALSE

Multiplicative

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69
Q

The total leverage measures the combined effect of operating and financial leverage on a firm’s risk.

T or F?

A

TRUE

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70
Q

Total leverage exists whenever the percentage change in earnings per share (EPS) resulting from a given percentage change in sales is greater than the percentage change in sales.

T or F?

A

TRUE

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71
Q

The base level of sales must be held constant to compare the total leverage associated with different levels of fixed costs.

T or F?

A

TRUE

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72
Q

With the existence of fixed operating costs, an increase in sales will result in ________ increase in EBIT.
A) a proportional
B) an equal
C) a less than proportional
D) a more than proportional

A

D

73
Q

________ leverage is concerned with the relationship between sales revenues and earnings before interest and taxes.
A) Investing
B) Operating
C) Variable
D) Total

A

B

74
Q

________ is the potential use of fixed operating costs to magnify the effects of changes in sales on earnings before interest and taxes.
A) Financial leverage
B) Operating leverage
C) Operating budget
D) Ratio analysis

A

B

75
Q

With the existence of fixed operating costs, a decrease in sales will result in ________ in EBIT.
A) a proportional increase
B) an equal increase
C) a less than proportional decrease
D) a more than proportional decrease

A

D

76
Q

A decrease in fixed operating costs will result in ________ in the degree of financial leverage.
A) a decrease
B) an increase
C) no change
D) an undetermined change

A

D

77
Q

An increase in fixed operating costs will result in ________.
A) a decrease in the degree of operating leverage
B) an increase in the degree of operating leverage
C) a decrease in the degree of financial leverage
D) an increase in the degree of financial leverage

A

B

78
Q

As fixed operating costs increase and all other factors are held constant, ________.
A) the degree of operating leverage will increase
B) the degree of operating leverage will decrease
C) the degree of total leverage will decrease
D) the degree of total leverage will increase

A

B

79
Q

Operating leverage measures the effect of fixed operating costs on the relationship between ________.
A) sales and EBIT
B) sales and EPS
C) EBIT and EPS
D) EBIT and dividend

A

A

80
Q

Financial leverage measures the effect of fixed financial costs on the relationship between ________.
A) sales and EBIT
B) sales and EPS
C) EBIT and EPS
D) EBIT and preference dividend

A

C

81
Q

________ leverage is concerned with the relationship between earnings before interest and taxes and earnings per share.
A) Financial
B) Operating
C) Variable
D) Total

A

A

82
Q

In theory, a firm should maintain financial leverage consistent with a capital structure that ________.
A) meets the industry standards
B) meets the investor expectations
C) maximizes the owner’s wealth
D) maximizes dividends

A

C

83
Q

The degree of financial leverage is the ratio of ________ to percentage change in EBIT.
A) operating profit
B) percentage change in sales
C) percentage change in EPS
D) long-term debt

A

C

84
Q

________ is the potential use of fixed financial charges to magnify the effects of changes in earnings before interest and taxes on a firm’s earnings per share.
A) Financial leverage
B) Operating leverage
C) Total leverage
D) Degree of operating leverage

A

A

85
Q

Financial leverage measures the effect of fixed financing costs on the relationship between ________.
A) sales and EBIT
B) sales and EPS
C) EBIT and EPS
D) net income and sales

A

C

86
Q

________ leverage measures the effect of fixed ________ costs on the relationship between EBIT and EPS.
A) Operating; operating
B) Financial; financial
C) Operating; financial
D) Financial; operating

A

B

87
Q

Fixed financial charges include ________.
A) common stock dividends and bond interest expense
B) common stock dividends and preferred stock dividends
C) bond interest expense and preferred stock dividends
D) stock repurchase expense

A

C

88
Q

Higher financial leverage causes ________ to increase more for a given increase in ________.
A) EBIT; sales
B) EPS; sales
C) EPS; EBIT
D) EBIT; EPS

A

C

89
Q

________ is the potential use of fixed costs to magnify the effect of changes in sales on the firm’s earnings per share.
A) Investing leverage
B) Total leverage
C) Operating leverage
D) Financial leverage

A

B

90
Q

Through the effects of financial leverage, when EBIT increases, ________. A) earnings per share will increase
B) earnings per share will decrease
C) fixed operating costs will decrease
D) fixed operating costs will increase

A

A

91
Q

________ leverage is concerned with the relationship between sales revenue and earnings per share.
A) Financial
B) Operating
C) Variable
D) Total

A

D

92
Q

Because the degree of total leverage is multiplicative and not additive, when a firm has very high operating leverage it can moderate its total risk by ________.
A) increasing sales
B) using a higher level of financial leverage
C) increasing EBIT
D) using a lower level of financial leverage

A

D

93
Q

Total leverage measures the effect of fixed costs on the relationship between ________.
A) sales and EBIT
B) sales and EPS
C) EBIT and EPS
D) EBIT and dividend

A

B

94
Q

A firm’s capital structure is the mix of short-term liabilities and long-term debt.

T or F?

A

FALSE

95
Q

Poor capital structure decisions can result in a high cost of capital, thereby making some unacceptable investments acceptable.

T or F?

A

FALSE

Acceptable investments unacceptable

96
Q

Debt is a relatively inexpensive source of capital because lenders take the least risk among the long- term contributors of capital.

T or F?

A

TRUE

97
Q

Debt capital is less risky than equity capital because a firm is legally obligated to pay interest to bondholders but they are not legally obligated to pay dividends to preferred or common stockholders.

T or F?

A

TRUE

98
Q

Due to its secondary position relative to equity, suppliers of debt capital face greater risk and therefore must be compensated with higher expected returns than suppliers of equity capital.

T or F?

A

FALSE

99
Q

All items on the right-hand side of a firm’s balance sheet, excluding current liabilities are sources of capital.

T or F?

A

TRUE

100
Q

Generally, the greater a firm’s times interest earned ratio, the less able it is to meet payments as they come due.

T or F?

A

FALSE

more

101
Q

A firm’s capital structure can significantly affect the firm’s value by affecting its risk and return.

T or F?

A

TRUE

102
Q

In general, a low times interest earned ratio and a low fixed-payment coverage ratio are associated with a high degree of financial leverage.

T or F?

A

TRUE

103
Q

The probability that a firm will become bankrupt is largely dependent on its level of both business and financial risk.

T or F?

A

TRUE

104
Q

Holding all other factors constant, a firm that is subject to a greater level of business risk should employ more total leverage than an otherwise equivalent firm that is subject to a lesser level of business risk.

T or F?

A

FALSE

105
Q

In general, the greater a firm’s operating leverage, the higher its business risk.

T or F?

A

TRUE

106
Q

Business risk is the risk that is reflected in fluctuations of the firm’s cash flows before considering any debt financing.

T or F?

A

TRUE

107
Q

Financial risk refers to fluctuations in a firm’s cash flows that occur because the firm uses financing sources like debt and preferred stock.

T or F?

A

TRUE

108
Q

Business risk is the risk to the firm of being unable to cover required financial obligations.

T or F?

A

FALSE

109
Q

The more fixed cost financing a firm has in its capital structure, the greater is its financial leverage and risk.

T or F?

A

TRUE

110
Q

Asymmetric information results when managers of a firm have more information about the firm’s operations and future prospects than investors have.

T or F?

A

TRUE

111
Q

In general, non-U.S. companies have much higher debt ratios than their U.S. counterparts because financial markets are much more developed in the United States than elsewhere.

T or F?

A

TRUE

112
Q

Effective capital structure decisions can lower the cost of capital, resulting in higher NPVs and more acceptable projects, thereby increasing the value of a firm.

T or F?

A

TRUE

113
Q

The pecking order theory describes a hierarchy of financing beginning with retained earnings, followed by debt financing, and finally external equity financing.

T or F?

A

TRUE

114
Q

A shift toward more fixed costs increases business risk, which in turn causes earnings before interest and taxes to increase by less for a given increase in sales.

T or F?

A

FALSE

more

115
Q

When considering the decision to shift a firm’s cost structure away from variable costs toward more fixed costs, a financial manager must weigh the increased financial risk associated with greater operating leverage against the expected increase in returns.

T or F?

A

FALSE

116
Q

Because of the extensive research conducted in recent years in the area of capital structure theory, it is now possible for financial managers to pinpoint with great accuracy a firm’s optimal capital structure.

T or F?

A

FALSE

117
Q

Despite the extensive research conducted in recent years in the area of capital structure theory, it is not yet possible to provide financial managers with a specified methodology for use in determining a firm’s optimal capital structure.

T or F?

A

TRUE

118
Q

In general, a firm’s theoretical optimal capital structure is that which balances the tax benefits of debt financing against the increase probability of bankruptcy that result from its use.

T or F?

A

TRUE

119
Q

In general, a firm’s theoretical optimal capital structure is that which balances the tax benefits of equity financing against the increase probability of bankruptcy that results from its use.

T or F?

A

FALSE

Debt financing

120
Q

The pecking order explanation of capital structure states that a hierarchy of financing exists for firms, in which retained earnings are employed first, followed by debt financing and finally by external equity financing.

T or F?

A

TRUE

121
Q

The pecking order explanation of capital structure states that a hierarchy of financing exists for firms, in which new external debt financing is employed first, followed by retained earnings and finally by external equity financing.

T or F?

A

FALSE

122
Q

The asymmetric information explanation of capital structure suggests that firms will issue new equity only when the managers believe the firm’s stock is overvalued; as a result, issuing new equity is considered a negative signal that will result in a decline in share price.

T or F?

A

TRUE

123
Q

The asymmetric information explanation of capital structure suggests that firms will issue new debt only when the managers believe the firm’s stock is overvalued; as a result, issuing new debt is considered a negative signal that will result in a decline in share price.

T or F?

A

FALSE

Stock

124
Q

Holding all other factors constant, a firm that is subject to a greater level of business risk should employ less operating leverage than an otherwise equivalent firm that is subject to a lesser level of business risk.

T or F?

A

TRUE

125
Q

Holding all other factors constant, a firm that is subject to a greater level of business risk should employ more operating leverage than an otherwise equivalent firm that is subject to a lesser level of business risk.

T or F?

A

FALSE

126
Q

Holding all other factors constant, a firm that is subject to a greater level of business risk should employ less financial leverage than an otherwise equivalent firm that is subject to a lesser level of business risk.

T or F?

A

TRUE

127
Q

Holding all other factors constant, a firm that is subject to a greater level of business risk should employ more financial leverage than an otherwise equivalent firm that is subject to a lesser level of business risk.

T or F?

A

FALSE

128
Q

Holding all other factors constant, a firm that is subject to a greater level of business risk should employ less total leverage than an otherwise equivalent firm that is subject to a lesser level of business risk.

T or F?

A

TRUE

129
Q

A firm’s ________ is the mix of long-term debt and equity utilized by the firm, which may significantly affect its value by affecting return and risk.
A) dividend policy
B) capital budget
C) capital structure
D) working capital

A

C

130
Q

The lower risk nature of long-term debt in a firm’s capital structure is due to the fact that ________.
A) the debt holders are the true owners of the firm
B) equity capital has a fixed return
C) creditors have a higher position in the priority of claims
D) dividend payments are tax-deductible

A

C

131
Q

Which of the following is a reason why equity capital is considered riskier than debt capital?
A) Equity capital has a higher priority claim against assets and earnings.
B) Equity capital requires regular periodic payments in the form of dividends.
C) Equity capital expects dividend payments which are not tax-deductible.
D) Equity capital remains invested in a firm indefinitely.

A

D

132
Q

The inexpensive nature of long-term debt in a firm’s capital structure is partly because ________.
A) the debt holders are the true owners of the firm
B) equity capital has a fixed return
C) long-term debt has a fixed return and a maturity date
D) dividend payments are tax-deductible

A

C

133
Q

The inexpensive nature of long-term debt in a firm’s capital structure is partly because ________.
A) the equity holders are the true owners of the firm
B) equity capital has a fixed return
C) creditors have a higher position in the priority of claims
D) dividend payments are tax-deductible

A

C

134
Q

The inexpensive nature of long-term debt in a firm’s capital structure is partly because ________.
A) the equity holders are the true owners of the firm
B) equity capital has a fixed return
C) interest payments are tax-deductible
D) equity holders have a higher position in the priority of claims

A

C

135
Q

Which of the following is a basic source of capital for a firm?
A) short-term debt
B) discounts from suppliers
C) current liabilities
D) common stock

A

D

136
Q

A decrease in the use of financing that requires fixed payments will result in a(n)________.
A) increase in financial risk
B) decrease in financial risk
C) increase in operating leverage
D) decrease in operating leverage

A

B

137
Q

As debt is substituted for equity in the capital structure and the debt ratio increases, the behavior of the overall cost of capital is partially explained by ________.
A) the tax-deductibility of interest payments
B) the increase in the number of common shares outstanding
C) the reduction in risk as perceived by the common shareholders
D) the decrease in the cost of equity

A

A

138
Q

According to the pecking order theory, which of the following is the order in which corporations use different financing sources to fund investment projects?
A) retained earnings, equity, debt
B) retained earnings, debt, equity
C) debt, retained earnings, equity
D) equity, retained earnings, debt

A

B

139
Q

________ is the risk reflected in fluctuations of a firm’s cash flows because it uses debt or other fixed- cost financing.
A) Systematic risk
B) Business risk
C) Financial risk
D) Diversifiable risk

A

C

140
Q

________ is the risk that is reflected in fluctuations of the firm’s cash flows before considering any debt financing.
A) Systematic risk
B) Business risk
C) Financial risk
D) Diversifiable risk

A

B

141
Q

Which of the following affects business risk?
A) operating leverage
B) interest rate stability
C) preferred stock
D) financial lease

A

A

142
Q

Revenue stability affects ________.
A) dividend risk
B) maturity risk
C) business risk
D) interest rate risk

A

C

143
Q

Which of the following is a difference between debt and equity capital?
A) Debt capital does not require periodic payments, whereas equity capital requires period payments.
B) Debt capital requires returns in proportion to profits, whereas equity capital requires a fixed rate of return.
C) Debt capital provides a tax shield, whereas equity capital does not provide a tax shield.
D) Debt capital affects operating leverage, whereas equity capital affects financial leverage.

A

C

144
Q

Which of the following is a difference between debt and equity capital?
A) Debt capital does not require periodic payments, whereas equity capital requires period payments.
B) Debt capital requires a fixed rate of return, whereas equity capital requires returns in proportion to profits.
C) Debt capital does not provides a tax shield, whereas equity capital provides a tax shield.
D) Debt capital affects operating leverage, whereas equity capital affects financial leverage.

A

B

145
Q

After satisfying obligations to creditors, the government, and preferred stockholders, any remaining earnings will most likely be allocated to ________.
A) common shareholders as cash dividends
B) common shareholders as stock dividends
C) other firms requiring capital
D) pay future preferred dividends

A

A

146
Q

The conflict resulting from a manager’s desire to increase a firm’s risk without increasing current borrowing costs and lenders’ desire to limit lending is one effect of the ________ problem.
A) agency
B) leverage
C) capital
D) variable cost

A

A

147
Q

Operating and financial constraints placed on a corporation by loan provision are ________.
A) agency costs to lenders
B) agency costs to a firm
C) necessary to regulate ownership of a firm
D) necessary to control the risk of a firm

A

B

148
Q

Management has just discovered an excellent investment for which it needs additional funding. Relative to the discussion on asymmetric information, the firm will ________.
A) finance with new common stock if management believes the firm is undervalued
B) finance with debt if management believes the firm is undervalued
C) finance with debt if management believes the firm is overvalued
D) finance with preferred stock if the firm is at value

A

B

149
Q

The EBIT-EPS approach to capital structure involves selecting the capital structure that maximizes earnings before interest and taxes (EBIT) over the expected range of earnings per share (EPS).

A

FALSE

Maximizes EPS over the expected range of EBIT

150
Q

The EBIT-EPS analysis tends to concentrate on maximization of earnings rather than maximization of owners’ wealth.

T or F?

A

TRUE

151
Q

The financial breakeven point represents the level of earnings after interest and taxes necessary for a firm to cover its fixed operating and financial changes—that is, the point at which dividends per share is equal to zero.

T or F?

A

FALSE

EBIT = 0

152
Q

The higher the financial breakeven point and the steeper the slope of the capital structure line, the greater the financial risk.

T or F?

A

TRUE

153
Q

The higher the degree of financial leverage (DFL), the greater the leverage a given financing plan has, and the steeper its slope when plotted on EBIT-EPS axes.

T or F?

A

TRUE

154
Q

The steeper the slope of the EBIT-EPS capital structure line, the lower is the financial risk.

T or F?

A

FALSE

higher

155
Q

Because risk premiums increase with increases in financial leverage, maximizing EPS does not assure owners’ wealth maximization.

T or F?

A

TRUE

156
Q

The basic shortcoming of EBIT-EPS analysis is that this model focuses on the maximization of earnings rather than on the maximization of owner wealth as reflected in a firm’s stock price.

T or F?

A

TRUE

157
Q

The basic shortcoming of EBIT-EPS analysis is that this model focuses on the maximization of stock returns rather than on the maximization of share price.

T or F?

A

FALSE

earnings

158
Q

In the EBIT-EPS approach to capital structure, risk is represented by ________.
A) the slope of the capital market line
B) shifts in the cost of debt capital
C) the slope of the capital structure line
D) shifts in the times-interest-earned ratio

A

C

159
Q

The EBIT-EPS approach to capital structure proposes that an optimal capital structure be selected which ________.
A) maximizes the weighted average cost of capital
B) minimizes the cost of debt
C) maximizes the EPS
D) minimizes dividends

A

C

160
Q

The major shortcoming of the EBIT-EPS approach to capital structure is that ________.
A) the technique does not promote the maximization of shareholder wealth
B) the technique does not consider the cost of capital
C) the technique only considers leverage-related risk
D) the technique does not maximize earnings per share

A

A

161
Q

The basic shortcoming of the EBIT-EPS approach to capital structure is ________.
A) that the optimal capital structure is difficult to compute
B) its disregard for the presence of preferred stock in the capital structure
C) its disregard for the firm’s dividend policy
D) that it concentrates on the maximization of EPS rather than the maximization of owner’s wealth

A

D

162
Q

Minimizing the weighted average cost of capital allows management to undertake a larger number of profitable projects, thereby further increasing the value of a firm.

T or F?

A

TRUE

163
Q

Optimal capital structure is the capital structure at which the weighted average cost of capital is minimized, thereby maximizing a firm’s value.

T or F?

A

TRUE

164
Q

An increase in fixed operating and financial cost results in an increase in risk, since the firm will have to achieve a higher level of sales just to break even.

T or F?

A

TRUE

165
Q

The cost of equity is greater than the cost of debt and increases with increasing financial leverage, but generally less rapidly than the cost of debt.

T or F?

A

FALSE

166
Q

The cost of equity increases with increasing financial leverage in order to compensate the stockholders for the higher degree of financial risk.

T or F?

A

TRUE

167
Q

As financial leverage increases, the cost of debt initially remains constant and then rises, while the cost of equity always rises.

T or F?

A

TRUE

168
Q

If we assume that EBIT is constant, the value of a firm is maximized by minimizing the weighted average cost of capital.

T or F?

A

TRUE

169
Q

In theory, a firm’s optimal capital structure is that which minimized the firm’s overall cost of capital resulting in a maximization of the market value of a firm.

T or F?

A

TRUE

170
Q

The overriding objective of the capital structure decision should be to choose the level of debt that results in the largest possible share price.

T or F?

A

TRUE

171
Q

The optimal capital structure is the one that balances ________.
A) return and risk factors in order to maximize profits
B) return and risk factors in order to maximize earnings per share
C) return and risk factors in order to maximize market value
D) return and risk factors in order to maximize dividends

A

C

172
Q

Beginning with a zero-leverage company, as debt is substituted for equity in the capital structure ________.
A) the overall cost of capital first rises, reaches a maximum, and then declines
B) the overall cost of capital declines
C) the overall cost of capital first declines, reaches a minimum, and then rises
D) the overall cost of capital rises

A

C

173
Q

Poor capital structure decisions can result in ________ the cost of capital, resulting in ________ acceptable investments.
A) increasing; fewer
B) decreasing; more
C) increasing; more
D) decreasing; fewer

A

A

174
Q

According to the traditional approach to capital structure, the value of a firm will be maximized when ________.
A) the financial leverage is maximized
B) the cost of debt is minimized
C) the weighted average cost of capital is minimized
D) the dividend payout is maximized

A

C

175
Q

In the traditional approach to capital structure, as the amount of debt increases in a firm’s capital structure, ________.
A) the cost of equity rises faster than the cost of debt
B) the cost of debt rises faster than the cost of equity
C) debt becomes less risky
D) equity cost is unaffected

A

A

176
Q

The value of a firm at optimum capital structure is computed as ________.
A) earnings before interest and taxes times one less tax rate divided by one plus weighted average cost of capital
B) earnings before interest and taxes times one less tax rate divided by weighted average cost of capital
C) operating cash flow divided by weighted average cost of capital
D) operating cash flow divided by one plus weighted average cost of capital

A

B

177
Q

Firms having stable and predictable revenues can more safely employ highly leveraged capital structures than can firms with volatile patterns of sales revenue.

T or F?

A

TRUE

178
Q

The reason why maximizing share value and maximizing EPS do not give the same optimal capital structure is because ________.
A) EPS maximization does not consider risk
B) share value maximization does not consider risk
C) EPS maximization considers cash flows
D) EPS maximization does consider risk

A

A

BSA 36P FM II (LONG-TERM) (10 decks)

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