Reading 32- LOS b ～ Q1－5 black, regarding, following, statements, class

spaceedu

1.Which of the following statements regarding leverage is TRUE?

A)   A firm with high business risk is more likely to increase its use of financial leverage than a firm with low business risk.

B)   Financial leverage is inversely related to operating leverage.

C)   High levels of financial leverage increase business risk while high levels of operating leverage will decrease business risk.

D)   A firm with low operating leverage has a small proportion of its total costs in fixed costs.

2.Given the following information on the annual operating results for ArtFrames, a producer of quality metal picture frames, what is the degree of operating leverage (DOL) and the degree of financial leverage (DFL)?

§ Sales of $3.5 million

§ Variable Costs at 45% of sales

§ Fixed Costs of $1.05 million

§ Debt interest payments on $750,000 issued with an annual 9.0% coupon (current yield is 7.0%)

Which of the following choices is closest to the correct answer? ArtFrame’s DOL and DFL are:

DOL

DFL

 

A)        3.00                 1.50

B)        2.20                 1.50

C)        2.20                 1.08

D)        3.00                 1.08

3.Stromburg Corporation's sales are $75,000,000. Fixed costs, including research and development, are $40,000,000, while variable costs amount to 30 percent of sales. Stromburg plans an expansion which will generate additional fixed costs of $15,000,000, decrease variable costs to 25 percent of sales, and permit sales to increase to $100,000,000. What is Stromburg's degree of operating leverage at the new projected sales level?

A)   4.20.

B)   3.50.

C)   4.67.

D)   3.75.

4.The following information reflects the projected operating results for Opstalan, a catalog printer.

§ Sales of $5.0 million.

§ Variable Costs at 40% of sales.

§ Fixed Costs of $1.0 million.

§ Debt interest payments on $1.5 million issued with an annual 7.0% coupon (current yield is 8.0%).

§ Tax Rate of 0.0%.

Opstalan’s degree of total leverage (DTL) is closest to:

A)   1.41.

B)   1.50.

C)   1.59.

D)   2.58.

5.Which of the following statements about leverage is CORRECT?

A)   A decrease in interest expense will increase the company's degree of total leverage.

B)   If the company has no debt outstanding, then its degree of total leverage equals its degree of operating leverage.

C)   An increase in interest expense will reduce the company's degree of financial leverage.

D)   An increase in fixed costs (holding sales and variable costs constant) will reduce the company's degree of operating leverage.

spaceedu

1.Which of the following statements regarding leverage is TRUE?

A)   A firm with high business risk is more likely to increase its use of financial leverage than a firm with low business risk.

B)   Financial leverage is inversely related to operating leverage.

C)   High levels of financial leverage increase business risk while high levels of operating leverage will decrease business risk.

D)   A firm with low operating leverage has a small proportion of its total costs in fixed costs.

The correct answer was D)

A firm with high operating leverage has a high percentage of its total costs in fixed costs.

2.Given the following information on the annual operating results for ArtFrames, a producer of quality metal picture frames, what is the degree of operating leverage (DOL) and the degree of financial leverage (DFL)?

§ Sales of $3.5 million

§ Variable Costs at 45% of sales

§ Fixed Costs of $1.05 million

§ Debt interest payments on $750,000 issued with an annual 9.0% coupon (current yield is 7.0%)

Which of the following choices is closest to the correct answer? ArtFrame’s DOL and DFL are:

DOL

DFL

 

A)        3.00                 1.50

B)        2.20                 1.50

C)        2.20                 1.08

D)        3.00                 1.08

The correct answer was C)

The calculations are as follows:

First, calculate the operating results:

ArtFrames Annual Operating Results
Sales	$3,500,000
Variable Costs1	1,575,000
	1,925,000
Fixed Costs	1,050,000
EBIT	875,000
Interest Expense2	67,500
	807,500
1Variable costs = 0.45 * 3,500,000
2Interest Expense = 0.09 * 750,000

Second, calculate DOL:

DOL = (Sales – Variable Costs) / (Sales – Variable Costs – Fixed Costs)

= (3,500,000 – 1,575,000) / (3,500,000 – 1,575,000 – 1,050,000) = 2.20

Third, calculate DFL:

DFL = EBIT / (EBIT – I) = 875,000 / 807,500 = 1.08.

3.Stromburg Corporation's sales are $75,000,000. Fixed costs, including research and development, are $40,000,000, while variable costs amount to 30 percent of sales. Stromburg plans an expansion which will generate additional fixed costs of $15,000,000, decrease variable costs to 25 percent of sales, and permit sales to increase to $100,000,000. What is Stromburg's degree of operating leverage at the new projected sales level?

A)   4.20.

B)   3.50.

C)   4.67.

D)   3.75.

The correct answer was D)

Sales = $100,000,000

VC of 25% of sales = 25,000,000

FC of 40,000,000 + 15,000,000 = 55,000,000

DOL= [100,000,000 – 25,000,000] / [100,000,000 – 25,000,000 – 55,000,000] = 3.75

4.The following information reflects the projected operating results for Opstalan, a catalog printer.

§ Sales of $5.0 million.

§ Variable Costs at 40% of sales.

§ Fixed Costs of $1.0 million.

§ Debt interest payments on $1.5 million issued with an annual 7.0% coupon (current yield is 8.0%).

§ Tax Rate of 0.0%.

Opstalan’s degree of total leverage (DTL) is closest to:

A)   1.41.

B)   1.50.

C)   1.59.

D)   2.58.

The correct answer was C)

First, calculate the operating results:

Opstalan Annual Operating Results
Sales	$5,000,000
Variable Costs1	2,000,000
	3,000,000
Fixed Costs	1,000,000
EBIT	2,000,000
Interest Expense2	105,000
	1,895,000

¹Variable costs = 0.40 * 5,000,000
²Interest Expense = 0.07 * 1,500,000

Second, calculate DOL = (Sales – Variable Costs) / (Sales – Variable Costs – Fixed Costs) = 3,000,000 / 2,000,000 = 1.50

Third, calculate DFL = EBIT / (EBIT – I) = 2,000,000 / 1,895,000 = 1.06.

Finally, calculate DTL = DOL * DFL = 1.50 * 1.06 = 1.59.

5.Which of the following statements about leverage is CORRECT?

A)   A decrease in interest expense will increase the company's degree of total leverage.

B)   If the company has no debt outstanding, then its degree of total leverage equals its degree of operating leverage.

C)   An increase in interest expense will reduce the company's degree of financial leverage.

D)   An increase in fixed costs (holding sales and variable costs constant) will reduce the company's degree of operating leverage.

The correct answer was B)

If debt = 0 then DFL = 1 because DFL = EBIT/(EBIT - I)

If debt = 0 then I = 0 and DFL = EBIT/(EBIT - 0) = EBIT/EBIT = 1

DTL = (DOL)(DFL)

If DFL = 1 then DTL = (DOL)(1) which complies to DTL = DOL

An increase in interest expense will increase DFL, which will increase DTL. A decrease in interest expense will decrease DFL, which will decrease DTL. An increase in fixed costs will increase the company’s DOL.