标题: Corporate Finance【Reading 38】Sample [打印本页]
作者: kim226 时间: 2012-3-29 12:53 标题: [2012 L1] Corporate Finance【Session 11 - Reading 38】Sample
All else equal, a firm's business risk is higher when: A)
| the firm has low operating leverage. |
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B)
| variable costs are the highest portion of its expense. |
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C)
| fixed costs are the highest portion of its expense. |
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The higher the percentage of a firm's costs that are fixed, the higher the operating leverage, and the greater the firm's business risk and the more susceptible it is to business cycle fluctuations.
作者: kim226 时间: 2012-3-29 12:53
Which of the following statements about business risk and financial risk is least accurate? A)
| Business risk is the riskiness of the company's assets if it uses no debt. |
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B)
| The greater a company's business risk, the higher its optimal debt ratio. |
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C)
| Factors that affect business risk are demand, sales price, and input price variability. |
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The greater a company’s business risk, the lower its optimal debt ratio.
作者: kim226 时间: 2012-3-29 12:54
Variability in a firm’s operating income is most closely related to its:
Business risk is the uncertainty regarding the operating income of a company. Financial risk refers to the uncertainty caused by the fixed cost associated with borrowed money.
作者: kim226 时间: 2012-3-29 12:54
Which of the following factors is least likely to affect business risk? |
B)
| Interest rate variability. |
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Business risk can be defined as the uncertainty inherent in a firm’s return on assets (ROA). While changes in interest rates may impact the demand or input prices, there is a more direct impact on business risk with the other three choices.
作者: kim226 时间: 2012-3-29 12:54
Hughes Continental is assessing its business risk. Which of the following factors would least likely be considered in the analysis? |
B)
| Input price variability. |
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The main factors affecting business risk are demand variability, sales price variability, input price variability, ability to adjust output prices, and operating leverage. Debt levels affect financial risk, not business (operating) risk.
作者: kim226 时间: 2012-3-29 12:55
Financial risk is borne by:
Common shareholders are the residual owners of the company. As such, they experience the benefits of above-normal gains in good times and the pain of losses when the business is in a slow period. Financial leverage magnifies the variability of earnings per share due to the existence of the required interest payments.
作者: kim226 时间: 2012-3-29 12:55
The two major types of risk affecting a firm are: A)
| business risk and financial risk. |
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B)
| financial risk and cash flow risk. |
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C)
| business risk and collection risk. |
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Business risk is the uncertainty regarding the operating income of a company. Financial risk refers to the uncertainty caused by the fixed cost associated with borrowed money.
作者: kim226 时间: 2012-3-29 12:56
The uncertainty in return on assets due to the nature of a firm’s operations is known as:
Business risk is a function of the firm's revenue and expenses, resulting in operating income, or earnings before interest and taxes (EBIT). The main factors affecting business risk are demand variability, sales price variability, input price variability, ability to adjust output prices, and operating leverage. Tax efficiency is tied to mutual fund investing, while financial leverage requires the existence of debt.
作者: kim226 时间: 2012-3-29 12:57
During a period of expansion in the economy, compared to firms with lower operating expense levels, earnings growth for firms with high operating leverage will be:
If a high percentage of a firm's total costs are fixed, the firm is said to have high operating leverage. High operating leverage, other things held constant, means that a relatively small change in sales will result in a large change in operating income. Therefore, during an expansionary phase in the economy a highly leveraged firm will have higher earnings growth than a lesser leveraged firm. The opposite will happen during an economic contraction.
作者: kim226 时间: 2012-3-29 12:58
As financial leverage increases, what will be the impact on the expected rate of return and financial risk? |
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C)
| One will rise while the other falls. |
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A higher breakeven point resulting from increased interest costs associated with debt financing increases the risk of the company. Since the risk is tied to firm financing, it is referred to as financial risk. Given the positive risk-return relationship, the expected return of the company’s common stock also rises.
作者: kim226 时间: 2012-3-29 12:59
If a 10% increase in sales causes EPS to increase from $1.00 to $1.50, and if the firm uses no debt, then what is its degree of operating leverage?
Upon first glance, it appears there is not enough information to complete the problem. However when one realizes DTL = (DOL)(DFL) it is possible to complete this problem.
DTL = %∆EPS/%∆Sales = 5
DFL = EBIT/(EBIT-I) = 1.
(DOL)(1) =5
DOL= 5.
作者: kim226 时间: 2012-3-29 13:00
The management of Strings & All, Inc., a small, highly leveraged, electric guitar manufacturer, wants to reduce the company’s degree of total leverage (DTL) to 2.0. Currently, the company’s expected operating performance is as follows:
All else constant, to obtain a DTL of 2.0, management must:
A)
| reduce variable expenses by 30%. |
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B)
| increase variable expenses by 30%. |
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C)
| reduce variable expenses by 38.5%. |
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To obtain this result, we need to calculate the current variable costs, determine the variable costs that will result in a DTL ratio of 2.00, and calculate the percentage change.
Step 1: Calculate current variable costs (VC): VC = 0.6 × 500,000 = 300,000
Step 2: Calculate Variable costs needed to decrease the DTL to 2.0:
Rearranging the formula for DTL:
(Sales − Variable Costs) / (Sales − Variable Costs − Fixed Costs − Interest Expense)
results in:
Variable Costs (VC) = Sales − (2 × Fixed Costs) − (2 × Interest Expense) = 500,000 − (2 × 120,000) − (2 × 25,000) = 210,000
Step 3: Calculate percentage change:
DVC = (300,000 − 210,000) / 300,000 = 0.30, or 30%.
作者: kim226 时间: 2012-3-29 13:00
Which of the following statements about leverage is most accurate? A)
| An increase in fixed costs (holding sales and variable costs constant) will reduce the company's degree of operating leverage. |
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B)
| A decrease in interest expense will increase the company's degree of total leverage. |
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C)
| If the company has no debt outstanding, then its degree of total leverage equals its degree of operating leverage. |
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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
A decrease in interest expense will decrease DFL, which will decrease DTL. An increase in fixed costs will increase the company’s DOL.
作者: kim226 时间: 2012-3-29 13:00
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:
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.
作者: kim226 时间: 2012-3-29 13:00
Stromburg Corporation's sales are $75,000,000. Fixed costs, including research and development, are $40,000,000, while variable costs amount to 30% of sales. Stromburg plans an expansion which will generate additional fixed costs of $15,000,000, decrease variable costs to 25% 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?
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
作者: kim226 时间: 2012-3-29 13:01
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:
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 |
| Earnings before interest and taxes (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
作者: kim226 时间: 2012-3-29 13:01
Which of the following statements regarding leverage is most accurate? A)
| A firm with high business risk is more likely to increase its use of financial leverage than a firm with low business risk. |
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B)
| A firm with low operating leverage has a small proportion of its total costs in fixed costs. |
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C)
| High levels of financial leverage increase business risk while high levels of operating leverage will decrease business risk. |
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A firm with high operating leverage has a high percentage of its total costs in fixed costs.
作者: kim226 时间: 2012-3-29 13:02
A firm expects to produce 200,000 units of flour that can be sold for $3.00 per bag. The variable costs per unit are $2.00, the fixed costs are $75,000, and interest expense is $25,000. The degree of operating leverage (DOL) and the degree of total leverage (DTL) is closest to:
DOL = Q(P – V) / [Q(P – V) – F]
DOL = 200,000 (3 – 2) / [200,000(3 – 2) – 75,000] = 1.6
DTL = [Q(P - V) / Q(P - V) - F - I]
DTL = 200,000 (3 - 2) / [200,000 (3 - 2) - 75,000 - 25,000] = 2
作者: kim226 时间: 2012-3-29 13:02
All else equal, which of the following statements about operating leverage is least accurate? A)
| Lower operating leverage generally results in a higher expected rate of return. |
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B)
| Operating leverage reflects the tradeoff between variable costs and fixed costs. |
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C)
| Firms with high operating leverage experience greater variance in operating income. |
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Operating leverage is the trade off between fixed and variable costs. Higher operating leverage typically is indicative of a firm with higher levels of risk (greater income variance). Given the positive risk/return relationship, higher operating leverage firms are expected to have a higher rate of return. And, lower operating leverage firms are expected to have a lower rate of return.
作者: kim226 时间: 2012-3-29 13:02
Jayco, Inc. sells 10,000 units at a price of $5 per unit. Jayco's fixed costs are $8,000, interest expense is $2,000, variable costs are $3 per unit, and earnings before interest and taxes (EBIT) is $12,000. What is Jayco’s degree of financial leverage (DFL) and total leverage (DTL)?
DOL = [Q(P − V)] / [Q(P − V) − F] = [10,000(5 − 3)] / [10,000(5 − 3) − 8,000] = 1.67
DFL = EBIT / (EBIT − I) = 12,000 / (12,000 − 2,000) = 1.2
DTL = DOL × DFL = 1.67 × 1.2 = 2.0
作者: kim226 时间: 2012-3-29 13:03
Which of the following best describes a firm with low operating leverage? A large change in: A)
| earnings before interest and taxes result in a small change in net income. |
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B)
| sales result in a small change in net income. |
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C)
| the number of units a firm produces and sells result in a similar change in the firm’s earnings before interest and taxes. |
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Operating leverage is the result of a greater proportion of fixed costs compared to variable costs in a firm’s capital structure and is characterized by the sensitivity in operating income (earnings before interest and taxes) to change in sales. A firm that has equal changes in sales and operating income would have low operating leverage (the least it can be is one). Note that the relationship between operating income and net income is impacted by the degree of financial leverage, and the relationship between sales and net income is impacted by the degree of total leverage.
作者: kim226 时间: 2012-3-29 13:03
Which of the following events would decrease financial leverage? A)
| Issuing common stock to purchase assets. |
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C)
| Issuing debt to purchase assets. |
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Acquiring assets by issuing stock decreases the degree of financial leverage since total assets are increased but total liabilities remain the same.
作者: kim226 时间: 2012-3-29 13:04
FCO, Inc. (FCO) is comparing EBIT forecasts to help determine the impact its capital structure has on net income.
| Expected EBIT | EBIT + 10% |
EBIT | $80,000 | $88,000 |
Interest expense | 15,000 | 15,000 |
EBT | 65,000 | 73,000 |
Taxes | 26,000 | 29,200 |
Net income | 39,000 | 43,800 |
| Liabilities | 200,000 |
| Shareholder equity | 250,000 |
| Return on equity | 15.60% |
FCO’s degree of financial leverage is closest to:
The degree of financial leverage (DFL) is interpreted as the ratio of the percentage change in net income to the percentage change in EBIT. FCO can compare two EBIT forecasts to determine how net income is being driven by financial leverage.
作者: kim226 时间: 2012-3-29 13:05
Additional debt should be used in the firm’s capital structure if it increases: |
B)
| the value of the firm. |
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The key to finding the optimal capital structure is identifying the level of debt that will maximize firm value. Earnings and earnings per share are not critical in and of themselves when assessing firm value, because they do not consider risk.
作者: kim226 时间: 2012-3-29 13:05
Financial leverage magnifies: A)
| earnings per share variability. |
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C)
| operating income variability. |
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Financial leverage results in the existence of required interest payments and, hence, increased earnings per share variability. Higher debt ratios, given a fixed asset base, result in a greater earnings per share variability. Operating income is based on the products and assets of the firm and not on the firm’s financing and, hence, has no impact on financial leverage. Greater financial leverage is likely to reduce taxes due to the tax deductibility of interest payments.
作者: kim226 时间: 2012-3-29 13:05
Which of the following is a key determinant of operating leverage? A)
| The competitive nature of the business. |
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B)
| Level and cost of debt. |
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C)
| The tradeoff between fixed and variable costs. |
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Operating leverage can be defined as the trade off between variable and fixed costs.
作者: kim226 时间: 2012-3-29 13:06
Which of the following statements regarding the impact of financial leverage on a company’s net income and return on equity (ROE) is most accurate? A)
| Using financial leverage increases the volatility of ROE for a level of volatility in operating income. |
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B)
| If a firm has a positive operating profit margin, using financial leverage will always increase ROE. |
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C)
| Increasing financial leverage increases both risk and potential return of existing bondholders. |
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If a firm is financed with 100% equity, there is a direct relationship between changes in the firm’s ROE and changes in operating income. Adding financial leverage (debt) to the firm’s capital structure will cause ROE to become much more volatile and ROE will change more rapidly for a given change in operating income. The increased volatility in ROE reflects an increase in both risk and potential return for equity holders. Note that financial leverage results in increased default risk, but since existing bond holders are compensated by coupon interest and return of principal, their potential return is unchanged. Although financial leverage will generally increase ROE if a firm has a positive operating margin (EBIT/Sales), if the operating margin were small, the added interest expense could turn the firm’s net profit margin negative, which would in turn make ROE negative.
作者: kim226 时间: 2012-3-29 13:06
Munn Industrial Components currently finances its operations with 100% equity, but is considering changing its target capital structure to 70% equity and 30% debt. Munn has a large asset base, a 20% operating profit margin, and the average interest rate on debt is expected to be 6.0%. If Munn makes the change to its capital structure and EBIT is unchanged, what is most likely the impact on Munn’s net income and return on equity (ROE) respectively? | Impact on Net Income | Impact on Return on Equity |
You should be able to figure out this question with logic (without having to use calculations). The interest expense associated with using debt represents a fixed cost that reduces net income. However, the lower net income value is spread over a smaller base of equity capital, serving to increase the ROE.
作者: kim226 时间: 2012-3-29 13:07
Which of the following firms is likely to have a higher debt ratio? A)
| Bath & Books, which produces toiletries and other consumer staples that are in demand regardless of economic conditions. |
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B)
| Critter Care, which has a low debt rating due to the prior financial mismanagement by the chief executive officer. |
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C)
| Egg Harbor Furs, which serves as a wholesaler of fine furs and garments. |
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Bath & Books appears to have relatively little business risk, especially in relation to Egg Harbor Furs, which is likely to be a much more cyclical business. Creditors will be less willing to lend funds to Critter Care whose managers have shown poor money management skills in the past.
作者: kim226 时间: 2012-3-29 13:08
Wanton’s San Y’isidro Co. manufactures custom door knobs for international clients. Average Revenue is $35 per unit, variable costs are $15 per unit, and total costs are $200,000. If sales are 10,000 units, what is the firm's breakeven sales quantity?
For this problem you need 2 equations. Break-even quantity = Fixed Costs / (Price - Variable cost) Q = FC / (P - V) Fixed Costs = Total Costs - Variable Costs FC = TC - VC = 200,000 - 150,000 = 50,000
Q = 50,000 / (35 - 15) = 2,500
作者: kim226 时间: 2012-3-29 13:08
Jayco, Inc. has a division that makes red ink for the accounting industry. The unit has fixed costs of $10,000 per month, and is expected to sell 40,000 bottles of ink per month. If the variable cost per bottle is $2.00 what price must the division charge in order to breakeven?
40,000 = $10,000/(P - $2)
40,000P – $80,000 = $10,000
P = $90,000/40,000 = $2.25.
作者: kim226 时间: 2012-3-29 13:09
Annual fixed costs at King Mattress amount to $325,000. The variable cost of raw materials and labor is $120 for the typical mattress. Sales prices for mattresses average $160. How many units must King Mattress sell to break even?
QBreakeven = Fixed Cost / (Price – Variable Cost)
QBreakeven = $325,000 / (160 – 120) = 8,125
作者: kim226 时间: 2012-3-29 13:09
Jayco, Inc., sells blue ink for $4.00 a bottle. The ink's variable cost per bottle is $2.00. Ink has fixed cost of $10,000. What is Jayco's breakeven point in units?
QBE = [FC] / (P - V)
QBE = [10,000] / (4.00 - 2.00) = 5,000
作者: kim226 时间: 2012-3-29 13:09
Yangtze Delta High Technology produces multimedia-enabled wireless phones. The factory incurs rent, depreciation, salary, and other fixed costs totaling RMB 10 million per year. Also, the company incurs annual interest of RMB 3 million on debt. Each phone sold by Yangtze Delta sells for RMB 200. The variable cost per phone is RMB 150. Yangtze Delta’s operating breakeven quantity of sales is closest to:
The operating breakeven point is the quantity of product sold at which operating income is zero (revenue equals operating cost).
F = Fixed operating cost = RMB 10,000,000
P = Price per unit = RMB 200
V = Variable cost per unit = RMB 150
Operating breakeven quantity = F / (P − V) = 10,000,000 / (200 − 150) = 200,000.
作者: terpsichorefan 时间: 2013-4-26 19:28
thanks for sharing
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