Reading 46: Measures of Leverage-LOS b 习题精选 2011, interpret, period, center, style

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Session 11: Corporate Finance
Reading 46: Measures of Leverage

LOS b: Calculate and interpret the degree of operating leverage, the degree of financial leverage, and the degree of total leverage.

 

 

During a period of expansion in the economy compared to firms with lower operating expense levels, the earnings growth for firms with high operating leverage will be:

A) higher.

B) lower.

C) not enough information.

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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.

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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?

A) 5.0.

B) 4.7.

C) 4.2.

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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.

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Which of the following events would decrease financial leverage?

A) Paying dividends.

B) Issuing common stock to purchase assets.

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.

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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:

A) 0.80.

B) 0.60.

C) 1.25.

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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.

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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)?

DFL

DTL

A) 1.20 2.00

B) 1.33 1.75

C) 1.33 2.00

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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

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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.

B) sales result in a small change in net income.

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.

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Which of the following statements regarding leverage is most accurate?

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

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

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.

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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

DTL

A) 1.6 2.0

B) 1.3 1.3

C) 1.6 1.3

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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

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All else equal, which of the following statements about operating leverage is least accurate?

A) Operating leverage reflects the tradeoff between variable costs and fixed costs.

B) Lower operating leverage generally results in a higher expected rate of return.

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.

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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?

A) 4.20.

B) 3.50.

C) 3.75.

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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