Chapter 05 Operating and Financial Leverage

1. Leverage is the use of fixed costs to magnify returns at high levels of operation. -٠

True False

2. Leverage works best when volume is increasing.

True False

3. Operating leverage emphasizes the impact of using fixed assets in the business.

True False

4. Financial leverage emphasizes the impact of using debt in the business. ٠

True False

5. Operating leverage determines how income from operations is to be divided between debt holders and
stockholders.

True False

6. Operating leverage will change when a firm alters the mix of fixed capital resources and labor that it
uses.

True False

7. Contribution margin is equal to fixed costs minus variable costs.

True False

1
8. Property Taxes and depreciation expense are examples of variable costs.

True False

9. Sales commissions and raw material are variable costs.

True False

10 The contribution margin is equal to price per unit minus total costs per unit.
.
True False

11 As the contribution margin rises, the breakeven point goes down.

.
True False

12 A lower price for the firm's product will reduce the firm's breakeven point.
.
True False

13 If economic conditions were expected to be favorable, an investor would likely prefer a firm with a low
. degree of leverage.

True False

14 Use of financial leverage must consider risk, not just maximizing profit.
.
True False

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.

True False

2
16 Managers who are risk averse and uncertain about the future would most likely minimize combined
. leverage.

True False

17 Management should tailor the use of leverage to meet its own risk-taking desires.
.
True False

18 Cash breakeven analysis eliminates the depreciation expense and other non-cash charges from fixed
. costs.

True False

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.

True False

20 The closer a firm is to its break-even point, the lower the degree of operating leverage will be.
.
True False

21 Degree of operating leverage should be computed only over a profitable range of operations.
.
True False

22 Linear break-even analysis assumes that costs are linear functions of volume.
.
True False

23 Linear breakeven analysis and operating leverage are only valid within a relevant range of production.
.
True False

3
24 Financial leverage primarily affects the left-hand side of the balance sheet.
.
True False

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.

True False

26 The degree of financial leverage measures the percentage change in EPS for every 1 percent move in
. EBIT.

True False

27 If a firm has a DFL of 2.0, EPS will change 2% for every 1% change in volume.
.
True False

28 The degree of financial leverage is not influenced by the interest rate on debt, only the amount borrowed.
.
True False

29 A firm with a high degree of financial leverage could face financial difficulty even though it is in a stable
. industry.

True False

30 Operating income is not the same thing as EBIT.

.
True False

31 Operating leverage influences the bottom half of the income statement while financial leverage deals with
. the top half.

True False

4
32 The degree of combined leverage is the sum of the degree of operating leverage and the degree of
. financial leverage.

True False

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.

True False

34 Firms with cyclical sales should employ a high degree of leverage.

.
True False

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.

True False

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.

True False

37 In order to conduct a cash break-even analysis, the analyst must add back depreciation from fixed costs.
.
True False

38 An example of an adjustment for a cash break-even analysis would be adding back increases in accounts
. receivable.

True False

39 Degree of combined leverage considers the impact of a change in volume on the change in operating
. income.

True False

5
40 Financial leverage breakeven occurs when return on total assets is equal to the cost of borrowed funds.
.
True False

41 Increasing financial leverage will always lead to higher EPS because it reduces the number of shares
. outstanding.

True False

42 The concept of operating leverage involves the use of __________ to magnify returns at high levels of
. .operation

fixed costs .A
variable costs .B
marginal costs .C
semi-variable costs .D

43 ?Which of the following questions does break-even analysis attempt to address

.

?How much do changes in volume effect costs and profits .A

?At what point does the firm break even .B
?What is the most efficient level of fixed assets to employ .C
All of these .D

6
44 the contribution margin is defined as ,In break-even analysis
.

.price minus variable cost .A

.price minus fixed cost .B
.variable cost minus fixed cost .C
.fixed cost minus variable cost .D

45 a firm's profits are ,At the break-even point

.

.greater than zero .A

.less than zero .B
.equal to zero .C
Not enough information to tell .D

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?

A. $100,000
B. $30,000
C. $15,000
D. $145,000

47 If sales volume exceeds the break-even point, the firm will experience
.

A. an operating loss.
B. an operating profit.
C. an increase in plant and equipment.
D. an increase in stock price.

7
48 The break-even point can be calculated as
.

A. variable costs divided by contribution margin.

B. total costs divided by contribution margin.
C. variable cost times contribution margin.
D. fixed cost divided by contribution margin.

49 A highly automated plant would generally have

.

A. more variable than fixed costs.

B. more fixed than variable costs.
C. all fixed costs.
D. all variable costs.

50 If fixed costs rise while other variables stay constant

.

A. the breakeven point rises.

B. degree of operating leverage increases.
C. total profit declines.
D. all of these

51 If the price per unit decreases because of competition but the cost structure remains the same
.

A. the breakeven point rises.

B. the degree of combined leverage declines.
C. the degree of financial leverage declines.
D. All of these

8
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:

A. $5.00
B. $4.60
C. $5.40
D. $4.00

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:

A. $2.50
B. $6.75
C. $4.00
D. $4.50

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:

A. $27,000
B. $90,000
C. $80,000
D. $50,000

9
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?

A. 30,000 units
B. 11,286 units
C. 15,824 units
D. There is not enough information to determine the unit sales required.

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?

A. less than 6,000 units.

B. 6,000 units.
C. more than 6,000 units
D. There is not enough information to determine the unit break-even point.

57 A firm's break-even point will rise if

.

A. fixed costs decrease

B. contribution margins increase
C. price per unit rises
D. variable cost per unit rises

10
58 Davison Toaster Corp. sells its products for $150 per unit. It has the following costs:
.

The break-even point is

A. less than 3,000 units

B. 3,000 units
C. more than 3,500 units
D. not enough information has been provided to determine the break-even point.

59 Which of the following is true about the concept of leverage?

.

A. At the breakeven point, operating leverage is equal to zero.

B. Combined leverage measures the impact of operating and financial leverage on EBIT.
C. Financial leverage measures the impact of fixed costs on earnings.
D. None of these

60 A weakness of breakeven analysis is that it assumes:

.

A. revenue and costs are a linear (constant) function of volume.

B. prices and costs increase when the economy is strong and confidence is high.
C. cost of goods sold goes up as revenue increases.
D. there is no weakness.

11
61 A high DOL means:
.

A. there are high labor costs.

B. there is high debt.
C. there is a large amount of equity.
D. there are high fixed costs.

62 Which of the following is concerned with the change in operating profit as a result of a change in
. volume?

A. Financial leverage
B. Break-even point
C. Operating leverage
D. Combined leverage

63 Cash breakeven analysis

.

A. is helpful in analyzing the short-term outlook of the firm, particularly when it is in trouble
financially.
B. is important when analyzing long-term profitability.
C. includes depreciation expense as a fixed cost when calculating the degree of financial leverage.
D. None of these.

64 The degree of operating leverage may be defined as

.

A. the percent change in operating income divided by the percent change in unit volume.
B. Q (P-VC) divided by Q (P-VC) - FC.
C. S - TVC divided by S - TVC - FC.
D. all of these

12
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?

A. Less than 7,333 units

B. 7,333 units
C. More than 7,333 units
D. Not enough information has been provided to determine the cash break-even point

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.

A. Firm C will have a higher return on equity than H.

B. Firm H will have a higher return on equity than C.
C. The return on equity will not be affected by financial leverage.
D. The return on equity will be the same at an equal level of earnings.

67 The degree of operating leverage is computed as

.

A. percent change in operating profit divided by percent change in net income.

B. percent change in volume divided by percent change in operating profit.
C. percent change in EPS divided by percent change in operating income.
D. percent change in operating income divided by percent change in volume.

13
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?

A. A has a lower break-even point than B, but A's profit grows faster after the break-even.
B. A has a higher break-even point than B, but A's profit grows slower after the break-even.
C. B has a lower break-even point than A, but A's profit grows faster after break-even.
D. B has a lower break-even point than A, and profit grows the same rate for both companies after the
breakeven point.

69 Firms with a high degree of operating leverage are

.

A. easily capable of surviving large changes in sales volume.

B. usually trading off lower levels of risk for higher profits.
C. significantly affected by changes in interest rates.
D. trading off higher fixed costs for lower per-unit variable costs.

70 Financial leverage deals with:

.

A. the relationship of fixed and variable costs.

B. the relationship of debt and equity in the capital structure.
C. the entire income statement.
D. the entire balance sheet.

71 A conservative financing plan involves

.

A. heavy reliance on debt.

B. heavy reliance on equity.
C. high degree of financial leverage.
D. high degree of combined leverage.

14
72 A firm's earnings per share is not impacted by its financing plan at the point when
.

A. debt is equal to equity.

B. return on assets equals return on equity.
C. the cost of borrowed funds equals the return on equity.
D. the cost of borrowed funds equals the return on assets.

73 If EBIT equals $200,000 and interest equals $40,000, what is the degree of financial leverage?
.

A. 5.33x
B. 1.25x
C. .8125x
D. 4.33x

74 The degree of financial leverage is concerned with the relation between

.

A. changes in volume and changes in EPS.

B. changes in volume and changes in EBIT.
C. changes in EBIT and changes in EPS.
D. changes in EBIT and changes in operating income.

75 When a firm employs no debt

.

A. it has a financial leverage of one.

B. it has a financial leverage of zero.
C. its operating leverage is equal to its financial leverage.
D. it will not be profitable.

15
76 If a firm has the lowest possible degree of operating leverage and the lowest possible degree of financial
. leverage, then

A. DOL equals 1, and DFL equals 0.

B. DOL equals 0, and DFL equals 1.
C. DOL equals 1, and DFL equals 1.
D. none of these

77 Combined leverage is concerned with the relationship between

.

A. changes in EBIT and changes in EPS.

B. changes in volume and changes in EPS.
C. changes in volume and changes in EBIT.
D. changes in EBIT and changes in net income.

78 Which of the following is not true about leverage?

.

A. Operating leverage influences the top half of the income statement, determining EBIT.
B. Financial leverage deals with the bottom half of the income statement, determining EPS.
C. Combined leverage utilizes the entire income statement, showing the impact of change in volume
on EBIT.
D. None of these.

16
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.

A. Firm A.
B. Firm B.
C. Indifferent between the two.
D. It depends on how much financial leverage each firm has.

80 Refer to the figure above. The Degree of Operating Leverage is

.

A. 1.40x
B. 1.56x
C. 3.33x
D. 2.22x

81 Refer to the figure above. The Degree of Financial Leverage is

.

A. 1.29x
B. 4.20x
C. 3.50x
D. 1.18x

17
82 Refer to the figure above. The Degree of Combined Leverage is
.

A. 2.2x
B. 1.9x
C. 2.9x
D. 1.7x

83 Refer to the figure above. This firm's break-even point is

.

A. 445 units
B. 634 units
C. 714 units
D. 180 units

84 Refer to the figure above. The Degree of Operating Leverage (DOL) is

.

A. 1.62x
B. 1.80x
C. 3.50x
D. 1.40x

18
85 Refer to the figure above. The Degree of Financial Leverage (DFL) is
.

A. 3.50x
B. 1.40x
C. 1.95x
D. 1.25x

86 Refer to the figure above. The Degree of Combined Leverage (D.C.L.) is

.

A. 3.08x
B. 5.45x
C. 2.25x
D. 6.83x

87 Heavy use of long-term debt may be beneficial in an inflationary economy because

.

A. the debt may be repaid in more "expensive" dollars.

B. nominal interest rates exceed real interest rates.
C. inflation is associated with the peak of a business cycle.
D. the debt may be repaid in "cheaper" dollars.

88 Under which of the following conditions could the overuse of financial leverage be detrimental to the
. firm?

A. Stable industry.
B. Cyclical demand for the firm's products.
C. Upswing of business cycle.
D. Low interest cost compared to return on assets.

19
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?"

A. A has a lower break-even point than B, but A's profit grows faster after the break-even.
B. A has a higher break-even point than B, but A's profit grows slower after the break-even.
C. B has a lower break-even point than A, but A's profit grows faster after break-even.
D. B has a lower break-even point than A, and profit grows at the same rate for both companies after
the breakeven point.

90 A factory which relies on highly technical machinery, may choose to reduce their overall leverage
. position by

A. selling their machinery

B. increasing their accounts receivable
C. utilizing a higher level of equity
D. decreasing their variable costs per unit

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?

A. 6,034 units
B. 11,458 units
C. 12,375 units
D. 45,833

20
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

A. breaking even
B. lower than the break even
C. higher than the breakeven
D. in need of new financing

93 Match the following with the items below:

.

1. degree of combined leverage A reflection of the extent fixed assets and fixed costs are utilized
in the business firm. ____
2. fixed costs The amount of fixed costs covered by each unit of sales. This amount is derived by
subtracting variable costs from the sales price of each unit. ____
3. leverage (concept in general) Costs that move directly with a change in volume. ____
4. break-even analysis A measure of the impact of fixed costs on earnings from the operations
viewpoint of the firm. ____
5. combined leverage A numerical and graphical technique used to determine at what point the firm
will equate its costs and revenues. ____
6. variable costs The use of fixed charge obligations with the intent of magnifying the potential
returns to the owners of the firm. ____
7. nonlinear break-even analysis A measure of the amount of debt used in the capital structure of
the firm. ____
8. degree of financial leverage Costs that remain relatively constant regardless of the volume of
sales. ____
9. operating leverage A measure of the impact of debt on the earnings capability of the firm. ____
10. contribution margin The total impact of operating and financial leverage. ____
11. degree of operating leverage The use of break-even analysis based on the assumption that cost
and revenue relationships to quantity sold may vary at different levels of sales. ____
12. financial leverage A measure of the total effect on earnings per share of operating and financial
leverage. ____

21
94 From the following income statement, calculate:
. a) Degree of financial leverage.
b) Degree of operating leverage.
c) Degree of combined 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?

22
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.

23
05 Key

1. Leverage is the use of fixed costs to magnify returns at high levels of operation.

TRUE

24
Block - Chapter 05 #1
Blooms: Understand
Difficulty: Basic
Learning Objective: 05-01 Leverage represents the use of fixed cost items to magnify the firms results.

2. Leverage works best when volume is increasing.

TRUE

Block - Chapter 05 #2
Blooms: Understand
Difficulty: Basic
Learning Objective: 05-01 Leverage represents the use of fixed cost items to magnify the firms results.

3. Operating leverage emphasizes the impact of using fixed assets in the business.

TRUE

Block - Chapter 05 #3
Blooms: Understand
Difficulty: Basic
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.

4. Financial leverage emphasizes the impact of using debt in the business.

TRUE

Block - Chapter 05 #4
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.

5. Operating leverage determines how income from operations is to be divided between debt holders and
stockholders.

FALSE

25
Block - Chapter 05 #5
Blooms: Understand
Difficulty: Basic
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.

6. Operating leverage will change when a firm alters the mix of fixed capital resources and labor that it
uses.

TRUE

Block - Chapter 05 #6
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.

7. Contribution margin is equal to fixed costs minus variable costs.

FALSE

Block - Chapter 05 #7
Blooms: Understand
Difficulty: Basic
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.

8. Property Taxes and depreciation expense are examples of variable costs.

FALSE

Block - Chapter 05 #8
Blooms: Remember
Difficulty: Basic
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.

9. Sales commissions and raw material are variable costs.

TRUE

26
Block - Chapter 05 #9
Blooms: Remember
Difficulty: Basic
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.

10. The contribution margin is equal to price per unit minus total costs per unit.

FALSE

Block - Chapter 05 #10

Blooms: Remember
Difficulty: Intermediate
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.

11. As the contribution margin rises, the breakeven point goes down.

TRUE

Block - Chapter 05 #11

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

12. A lower price for the firm's product will reduce the firm's breakeven point.

FALSE

Block - Chapter 05 #12

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

13. If economic conditions were expected to be favorable, an investor would likely prefer a firm with a
low degree of leverage.

FALSE

27
AACSB: Analytic
Block - Chapter 05 #13
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 05-06 By increasing leverage
Learning Objective: but also its risk of failure.
Learning Objective: the firm increases its profit potential

14. Use of financial leverage must consider risk, not just maximizing profit.

TRUE

Block - Chapter 05 #14

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.
Learning Objective: 6

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.

FALSE

AACSB: Analytic
Block - Chapter 05 #15
Blooms: Evaluate
Difficulty: Intermediate
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.

16. Managers who are risk averse and uncertain about the future would most likely minimize combined
leverage.

TRUE

AACSB: Analytic
Block - Chapter 05 #16
Blooms: Evaluate
Difficulty: Intermediate
Learning Objective: 05-05 Combined leverage takes into account both the use of fixed assets and debt.

28
17. Management should tailor the use of leverage to meet its own risk-taking desires.

TRUE

Block - Chapter 05 #17

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-06 By increasing leverage
Learning Objective: but also its risk of failure.
Learning Objective: the firm increases its profit potential

18. Cash breakeven analysis eliminates the depreciation expense and other non-cash charges from fixed
costs.

TRUE

Block - Chapter 05 #18

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

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.

FALSE

Block - Chapter 05 #19

Blooms: Understand
Difficulty: Basic
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.

20. The closer a firm is to its break-even point, the lower the degree of operating leverage will be.

FALSE

Block - Chapter 05 #20

Blooms: Understand
Difficulty: Basic
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.

29
21. Degree of operating leverage should be computed only over a profitable range of operations.

TRUE

Block - Chapter 05 #21

Blooms: Remember
Difficulty: Basic
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.

22. Linear break-even analysis assumes that costs are linear functions of volume.

TRUE

Block - Chapter 05 #22

Blooms: Understand
Difficulty: Basic
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

23. Linear breakeven analysis and operating leverage are only valid within a relevant range of production.

TRUE

Block - Chapter 05 #23

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.

24. Financial leverage primarily affects the left-hand side of the balance sheet.

FALSE

Block - Chapter 05 #24

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.

30
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.

TRUE

Block - Chapter 05 #25

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.

26. The degree of financial leverage measures the percentage change in EPS for every 1 percent move in
EBIT.

TRUE

Block - Chapter 05 #26

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.

27. If a firm has a DFL of 2.0, EPS will change 2% for every 1% change in volume.

FALSE

AACSB: Analytic
Block - Chapter 05 #27
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.

28. The degree of financial leverage is not influenced by the interest rate on debt, only the amount
borrowed.

FALSE

Block - Chapter 05 #28

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.

31
29. A firm with a high degree of financial leverage could face financial difficulty even though it is in a
stable industry.

TRUE

AACSB: Analytic
Block - Chapter 05 #29
Blooms: Evaluate
Difficulty: Challenge
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.
Learning Objective: 05-06 By increasing leverage
Learning Objective: but also its risk of failure.
Learning Objective: the firm increases its profit potential

30. Operating income is not the same thing as EBIT.

FALSE

Block - Chapter 05 #30

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.

31. Operating leverage influences the bottom half of the income statement while financial leverage deals
with the top half.

FALSE

Block - Chapter 05 #31

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.
Learning Objective: 05-04

32. The degree of combined leverage is the sum of the degree of operating leverage and the degree of
financial leverage.

FALSE

32
Block - Chapter 05 #32
Blooms: Remember
Difficulty: Intermediate
Learning Objective: 05-05 Combined leverage takes into account both the use of fixed assets and debt.

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.

TRUE

AACSB: Analytic
Block - Chapter 05 #33
Blooms: Evaluate
Difficulty: Challenge
Learning Objective: 05-05 Combined leverage takes into account both the use of fixed assets and debt.

34. Firms with cyclical sales should employ a high degree of leverage.

FALSE

Block - Chapter 05 #34

Blooms: Understand
Difficulty: Challenge
Learning Objective: 05-06 By increasing leverage
Learning Objective: but also its risk of failure.
Learning Objective: the firm increases its profit potential

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.

TRUE

Block - Chapter 05 #35

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.

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.

TRUE
33
AACSB: Analytic
Block - Chapter 05 #36
Blooms: Evaluate
Difficulty: Challenge
Learning Objective: 05-06 By increasing leverage
Learning Objective: but also its risk of failure.
Learning Objective: the firm increases its profit potential

37. In order to conduct a cash break-even analysis, the analyst must add back depreciation from fixed
costs.

FALSE

Block - Chapter 05 #37

Blooms: Understand
Difficulty: Challenge
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

38. An example of an adjustment for a cash break-even analysis would be adding back increases in
accounts receivable.

FALSE

AACSB: Analytic
Block - Chapter 05 #38
Blooms: Apply
Difficulty: Challenge
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

39. Degree of combined leverage considers the impact of a change in volume on the change in operating
income.

FALSE

Block - Chapter 05 #39

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-05 Combined leverage takes into account both the use of fixed assets and debt.

34
40. Financial leverage breakeven occurs when return on total assets is equal to the cost of borrowed
funds.

TRUE

41. Increasing financial leverage will always lead to higher EPS because it reduces the number of shares
outstanding.

FALSE

Block - Chapter 05 #41

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-06 By increasing leverage
Learning Objective: but also its risk of failure.
Learning Objective: the firm increases its profit potential

42. The concept of operating leverage involves the use of __________ to magnify returns at high levels of
operation.

A. fixed costs
B. variable costs
C. marginal costs
D. semi-variable costs

Block - Chapter 05 #42

Blooms: Understand
Difficulty: Basic
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.

35
43. Which of the following questions does break-even analysis attempt to address?

A. How much do changes in volume effect costs and profits?

B. At what point does the firm break even?
C. What is the most efficient level of fixed assets to employ?
D. All of these

Block - Chapter 05 #43

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

44. In break-even analysis, the contribution margin is defined as

A. price minus variable cost.

B. price minus fixed cost.
C. variable cost minus fixed cost.
D. fixed cost minus variable cost.

Block - Chapter 05 #44

Blooms: Remember
Difficulty: Basic
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

45. At the break-even point, a firm's profits are ‫وو‬

A. greater than zero.

B. less than zero.
C. equal to
zero.
D. Not enough information to tell

36
Block - Chapter 05 #45
Blooms: Remember
Difficulty: Basic
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

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?

A. $100,000
B. $30,000
C. $15,000
D. $145,000

-+
AACSB: Analytic
Block - Chapter 05 #46
Blooms: Apply
Difficulty: Challenge
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

47. If sales volume exceeds the break-even point, the firm will experience

A. an operating loss.
B. an operating profit.
C. an increase in plant and equipment.
D. an increase in stock price.

Block - Chapter 05 #47

Blooms: Understand
Difficulty: Basic
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

37
48. The break-even point can be calculated as

A. variable costs divided by contribution margin.

B. total costs divided by contribution margin.
C. variable cost times contribution margin.
D. fixed cost divided by contribution margin.

Block - Chapter 05 #48

Blooms: Remember
Difficulty: Basic
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

49. A highly automated plant would generally have

A. more variable than fixed costs.

B. more fixed than variable costs.
C. ll fixed costs.
D. all variable costs.

Block - Chapter 05 #49

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.

50. If fixed costs rise while other variables stay constant

A. the breakeven point rises.

B. degree of operating leverage increases.
C. total profit declines.
D. all of these

38
AACSB: Analytic
Block - Chapter 05 #50
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.

51. If the price per unit decreases because of competition but the cost structure remains the same

A. the breakeven point rises.

B. the degree of combined leverage declines.
C. the degree of financial leverage declines.
D. All of these

AACSB: Analytic
Block - Chapter 05 #51
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

52.11 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:

A. $5.00
B. $4.60
C. $5.40
D. $4.00

39
AACSB: Analytic
Block - Chapter 05 #52
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

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:

A. $2.50
B. $6.75
C. $4.00
D. $4.50

AACSB: Analytic
Block - Chapter 05 #53
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

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:

A. $27,000
B. $90,000
C. $80,000
D. $50,000

40
AACSB: Analytic ‫ض‬
Block - Chapter 05 #54
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

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?

A. 30,000 units
B. 11,286 units
C. 15,824 units
D. There is not enough information to determine the unit sales required.

AACSB: Analytic
Block - Chapter 05 #55
Blooms: Apply
Difficulty: Challenge
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

41
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?

A. less than 6,000 units.

B. 6,000 units.
C. more than 6,000 units
D. There is not enough information to determine the unit break-even point.

AACSB: Analytic
Block - Chapter 05 #56
Blooms: Apply
Difficulty: Challenge
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

57. A firm's break-even point will rise if

A. fixed costs decrease

B. contribution margins increase
C. price per unit rises
D. variable cost per unit rises

Block - Chapter 05 #57

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

42
58. Davison Toaster Corp. sells its products for $150 per unit. It has the following costs:

The break-even point is

A. less than 3,000 units

B. 3,000 units
C. more than 3,500 units
D. not enough information has been provided to determine the break-even point.

AACSB: Analytic
Block - Chapter 05 #58
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

59. Which of the following is true about the concept of leverage?

A. At the breakeven point, operating leverage is equal to zero.

B. Combined leverage measures the impact of operating and financial leverage on EBIT.
C. Financial leverage measures the impact of fixed costs on earnings.
D. None of these

Block - Chapter 05 #59

Blooms: Understand
Difficulty: Challenge
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.
Learning Objective: 05-05 Combined leverage takes into account both the use of fixed assets and debt.

43
60. A weakness of breakeven analysis is that it assumes:

A. revenue and costs are a linear (constant) function of volume.

B. prices and costs increase when the economy is strong and confidence is high.
C. cost of goods sold goes up as revenue increases.
D. there is no weakness.

Block - Chapter 05 #60

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

61. A high DOL means:

A. there are high labor costs.

B. there is high debt.
C. there is a large amount of equity.
D. there are high fixed costs.

Block - Chapter 05 #61

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.

62. Which of the following is concerned with the change in operating profit as a result of a change in
volume?

A. Financial leverage
B. Break-even point
C. Operating leverage
D. Combined leverage

44
Block - Chapter 05 #62
Blooms: Understand
Difficulty: Basic
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.

63. Cash breakeven analysis

A. is helpful in analyzing the short-term outlook of the firm, particularly when it is in trouble
financially.
B. is important when analyzing long-term profitability.
C. includes depreciation expense as a fixed cost when calculating the degree of financial leverage.
D. None of these.

Block - Chapter 05 #63

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

64. The degree of operating leverage may be defined as

A. the percent change in operating income divided by the percent change in unit volume.
B. Q (P-VC) divided by Q (P-VC) - FC.
C. S - TVC divided by S - TVC - FC.
D. all of these

Block - Chapter 05 #64

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.

45
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?

A. Less than 7,333 units

B. 7,333 units
C. More than 7,333 units
D. Not enough information has been provided to determine the cash break-even point

AACSB: Analytic
Block - Chapter 05 #65
Blooms: Apply
Difficulty: Challenge
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

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.

A. Firm C will have a higher return on equity than H.

B. Firm H will have a higher return on equity than C.
C. The return on equity will not be affected by financial leverage.
D. The return on equity will be the same at an equal level of earnings.

AACSB: Analytic
Block - Chapter 05 #66
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 05-06 By increasing leverage
Learning Objective: but also its risk of failure.
Learning Objective: the firm increases its profit potential

46
67. The degree of operating leverage is computed as

A. percent change in operating profit divided by percent change in net income.

B. percent change in volume divided by percent change in operating profit.
C. percent change in EPS divided by percent change in operating income.
D. percent change in operating income divided by percent change in volume.

Block - Chapter 05 #67

Blooms: Remember
Difficulty: Basic
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.

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?

A. A has a lower break-even point than B, but A's profit grows faster after the break-even.
B. A has a higher break-even point than B, but A's profit grows slower after the break-even.
C. B has a lower break-even point than A, but A's profit grows faster after break-even.
D. B has a lower break-even point than A, and profit grows the same rate for both companies after
the breakeven point.

AACSB: Analytic
Block - Chapter 05 #68
Blooms: Analyze
Difficulty: Challenge
Learning Objective: 05-06 By increasing leverage
Learning Objective: but also its risk of failure.
Learning Objective: the firm increases its profit potential

47
69. Firms with a high degree of operating leverage are

A. easily capable of surviving large changes in sales volume.

B. usually trading off lower levels of risk for higher profits.
C. significantly affected by changes in interest rates.
D. trading off higher fixed costs for lower per-unit variable costs.

AACSB: Analytic
Block - Chapter 05 #69
Blooms: Analyze
Difficulty: Intermediate
Learning Objective: 05-06 By increasing leverage
Learning Objective: but also its risk of failure.
Learning Objective: the firm increases its profit potential

70. Financial leverage deals with:

A. the relationship of fixed and variable costs.

B. the relationship of debt and equity in the capital structure.
C. the entire income statement.
D. the entire balance sheet.

Block - Chapter 05 #70

Blooms: Understand
Difficulty: Basic
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.

71. A conservative financing plan involves

A. heavy reliance on debt.

B. heavy reliance on equity.
C. high degree of financial leverage.
D. high degree of combined leverage.

*-9/

48
Block - Chapter 05 #71
Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-06 By increasing leverage
Learning Objective: but also its risk of failure.
Learning Objective: the firm increases its profit potential

72. A firm's earnings per share is not impacted by its financing plan at the point when

A. debt is equal to equity.

B. return on assets equals return on equity.
C. the cost of borrowed funds equals the return on equity.
D. the cost of borrowed funds equals the return on assets.

AACSB: Analytic
Block - Chapter 05 #72
Blooms: Evaluate
Difficulty: Challenge
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.

73. If EBIT equals $200,000 and interest equals $40,000, what is the degree of financial leverage?

A. 5.33x
B. 1.25x
C. .8125x
D. 4.33x

AACSB: Analytic
Block - Chapter 05 #73
Blooms: Apply
Difficulty: Basic
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.

49
74. The degree of financial leverage is concerned with the relation between

A. changes in volume and changes in EPS.

B. changes in volume and changes in EBIT.
C. changes in EBIT and changes in EPS.
D. changes in EBIT and changes in operating income.

Block - Chapter 05 #74

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.

75. When a firm employs no debt

A. it has a financial leverage of one.

B. it has a financial leverage of zero.
C. its operating leverage is equal to its financial leverage.
D. it will not be profitable.

Block - Chapter 05 #75

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.

76. If a firm has the lowest possible degree of operating leverage and the lowest possible degree of
financial leverage, then

A. DOL equals 1, and DFL equals 0.

B. DOL equals 0, and DFL equals 1.
C. DOL equals 1, and DFL equals 1.
D. none of these

50
AACSB: Analytic
Block - Chapter 05 #76
Blooms: Evaluate
Difficulty: Challenge
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.

77. Combined leverage is concerned with the relationship between

A. changes in EBIT and changes in EPS.

B. changes in volume and changes in EPS.
C. changes in volume and changes in EBIT.
D. changes in EBIT and changes in net income.

Block - Chapter 05 #77

Blooms: Remember
Difficulty: Basic
Learning Objective: 05-05 Combined leverage takes into account both the use of fixed assets and debt.

78. Which of the following is not true about leverage?

A. Operating leverage influences the top half of the income statement, determining EBIT.
B. Financial leverage deals with the bottom half of the income statement, determining EPS.
C. Combined leverage utilizes the entire income statement, showing the impact of change in
volume on EBIT.
D. None of these.

Block - Chapter 05 #78

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.
Learning Objective: 05-05 Combined leverage takes into account both the use of fixed assets and debt.

51
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.

A. Firm A.
B. Firm B.
C. Indifferent between the two.
D. It depends on how much financial leverage each firm has.

AACSB: Analytic
Block - Chapter 05 #79
Blooms: Analyze
Difficulty: Intermediate
Learning Objective: 05-05 Combined leverage takes into account both the use of fixed assets and debt.

Block - Chapter 05

80. Refer to the figure above. The Degree of Operating Leverage is

A. 1.40x
B. 1.56x
C. 3.33x
D. 2.22x

52
AACSB: Analytic
Block - Chapter 05 #80
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.

81. Refer to the figure above. The Degree of Financial Leverage is

A. 1.29x
B. 4.20x
C. 3.50x
D. 1.18x

AACSB: Analytic
Block - Chapter 05 #81
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.

82. Refer to the figure above. The Degree of Combined Leverage is

A. 2.2x
B. 1.9x
C. 2.9x
D. 1.7x

53
AACSB: Analytic
Block - Chapter 05 #82
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 05-05 Combined leverage takes into account both the use of fixed assets and debt.

Block - Chapter 05

83. Refer to the figure above. This firm's break-even point is

A. 445 units
B. 634 units
C. 714 units
D. 180 units

AACSB: Analytic
Block - Chapter 05 #83
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

54
84. Refer to the figure above. The Degree of Operating Leverage (DOL) is

A. 1.62x
B. 1.80x
C. 3.50x
D. 1.40x

AACSB: Analytic
Block - Chapter 05 #84
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.

85. Refer to the figure above. The Degree of Financial Leverage (DFL) is

A. 3.50x
B. 1.40x
C. 1.95x
D. 1.25x

AACSB: Analytic
Block - Chapter 05 #85
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.

55
86. Refer to the figure above. The Degree of Combined Leverage (D.C.L.) is

A. 3.08x
B. 5.45x
C. 2.25x
D. 6.83x

AACSB: Analytic
Block - Chapter 05 #86
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 05-05 Combined leverage takes into account both the use of fixed assets and debt.

87. Heavy use of long-term debt may be beneficial in an inflationary economy because

A. the debt may be repaid in more "expensive" dollars.

B. nominal interest rates exceed real interest rates.
C. inflation is associated with the peak of a business cycle.
D. the debt may be repaid in "cheaper" dollars.

AACSB: Analytic
Block - Chapter 05 #87
Blooms: Evaluate
Difficulty: Challenge
Learning Objective: 05-06 By increasing leverage
Learning Objective: but also its risk of failure.
Learning Objective: the firm increases its profit potential

56
88. Under which of the following conditions could the overuse of financial leverage be detrimental to the
firm?

A. Stable industry.
B. Cyclical demand for the firm's products.
C. Upswing of business cycle.
D. Low interest cost compared to return on assets.

AACSB: Analytic
Block - Chapter 05 #88
Blooms: Evaluate
Difficulty: Intermediate
Learning Objective: 05-06 By increasing leverage
Learning Objective: but also its risk of failure.
Learning Objective: the firm increases its profit potential

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?"

A. A has a lower break-even point than B, but A's profit grows faster after the break-even.
B. A has a higher break-even point than B, but A's profit grows slower after the break-even.
C. B has a lower break-even point than A, but A's profit grows faster after break-even.
D. B has a lower break-even point than A, and profit grows at the same rate for both companies
after the breakeven point.

AACSB: Analytic
Block - Chapter 05 #89
Blooms: Analyze
Difficulty: Challenge
Learning Objective: 05-01 Leverage represents the use of fixed cost items to magnify the firms results.

57
90. A factory which relies on highly technical machinery, may choose to reduce their overall leverage
position by

A. selling their machinery

B. increasing their accounts receivable
C. utilizing a higher level of equity
D. decreasing their variable costs per unit

AACSB: Analytic
Block - Chapter 05 #90
Blooms: Analyze
Difficulty: Challenge
Learning Objective: 05-05 Combined leverage takes into account both the use of fixed assets and debt.

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?

A. 6,034 units
B. 11,458 units
C. 12,375 units
D. 45,833

AACSB: Analytic
Block - Chapter 05 #91
Blooms: Apply
Difficulty: Intermediate
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

58
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

A. breaking even
B. lower than the break even
C. higher than the breakeven
D. in need of new financing

If maximum interest expense = $24,000 ($400,000 x 6%) and EBIT = $42,500, company must be
operating above the break-even point.

AACSB: Analytic
Block - Chapter 05 #92
Blooms: Apply
Difficulty: Challenge
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

59
93. Match the following with the items below:

1. degree of combined leverage A reflection of the extent fixed assets and fixed costs are
utilized in the business firm. 9
2. fixed costs The amount of fixed costs covered by each unit of sales. This amount is derived by
subtracting variable costs from the sales price of each unit. 10
3. leverage (concept in general) Costs that move directly with a change in volume. 6
4. break-even analysis A measure of the impact of fixed costs on earnings from the
operations viewpoint of the firm. 11
5. combined leverage A numerical and graphical technique used to determine at what point the
firm will equate its costs and revenues. 4
6. variable costs The use of fixed charge obligations with the intent of magnifying the
potential returns to the owners of the firm. 3
7. nonlinear break-even analysis A measure of the amount of debt used in the capital structure
of the firm. 12
8. degree of financial leverage Costs that remain relatively constant regardless of the volume
of sales. 2
9. operating leverage A measure of the impact of debt on the earnings capability of the firm. 8
10. contribution margin The total impact of operating and financial leverage. 5
11. degree of operating leverage The use of break-even analysis based on the assumption that
cost and revenue relationships to quantity sold may vary at different levels of sales. 7
12. financial leverage A measure of the total effect on earnings per share of operating and financial
leverage. 1

Block - Chapter 05 #93

Blooms: Understand
Difficulty: Intermediate
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.
Learning Objective: 05-05 Combined leverage takes into account both the use of fixed assets and debt.
Learning Objective: 05-06 By increasing leverage
Learning Objective: but also its risk of failure.
Learning Objective: the firm increases its profit potential

60
94. From the following income statement, calculate:
a) Degree of financial leverage.
b) Degree of operating leverage.
c) Degree of combined leverage.

AACSB: Analytic
Block - Chapter 05 #94
Blooms: Apply
Difficulty: Challenge
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.
Learning Objective: 05-05 Combined leverage takes into account both the use of fixed assets and debt.

61
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?

AACSB: Analytic
Block - Chapter 05 #95
Blooms: Apply and Synthesis
Difficulty: Challenge
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.
Learning Objective: 05-06

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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.

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AACSB: Analytic
Block - Chapter 05 #96
Blooms: Apply
Difficulty: Challenge
Learning Objective: 05-01 Leverage represents the use of fixed cost items to magnify the firms results.
Learning Objective: 05-02 Break-even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.
Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by the firm.
Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure.
Learning Objective: 05-05 Combined leverage takes into account both the use of fixed assets and debt.
Learning Objective: 05-06 By increasing leverage
Learning Objective: but also its risk of failure.
Learning Objective: the firm increases its profit potential

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05 Summary

Category # of Questions

AACSB: Analytic 41

Block - Chapter 05 98

Blooms: Analyze 5

Blooms: Apply 26

Blooms: Apply and Synthesis 1

Blooms: Evaluate 9

Blooms: Remember 10

Blooms: Understand 45

Difficulty: Basic 21

Difficulty: Challenge 21

Difficulty: Intermediate 54

Learning Objective: 05-01 Leverage represents the use of fixed cost items to magnify the firms results. 4

Learning Objective: 05-02 Break- 32

even analysis allows the firm to determine the magnitude of operations necessary to avoid loss.

Learning Objective: 05-03 Operating leverage indicates the extent fixed assets (plant and equipment) are utilized by 29
the firm.

Learning Objective: 05-04 1

Learning Objective: 05-04 Financial leverage shows how much debt the firm employs in its capital structure. 25

Learning Objective: 05-05 Combined leverage takes into account both the use of fixed assets and debt. 14

Learning Objective: 05-06 1

Learning Objective: 05-06 By increasing leverage 14

Learning Objective: 6 1

Learning Objective: but also its risk of failure. 14

Learning Objective: the firm increases its profit potential 14

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