Reading 29: Capital Structure and Leverage LOS a～ Q1-11

business, highest, higher, costs, equal

LOS a: Define and explain leverage, business risk, sales risk, operating risk, and financial risk, and classify a risk, given a description.

Q1. All else equal, a firm's business risk is higher when:

A) fixed costs are the highest portion of its expense.

B) the firm has low operating leverage.

C) variable costs are the highest portion of its expense.

Q2. 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.

B) The greater a company's business risk, the higher its optimal debt ratio.

C) Factors that affect business risk are demand, sales price, and input price variability.

Q3. Variability in a firm’s operating income is most closely related to its:

A) internal risk.

B) business risk.

C) financial risk.

Q4. Which of the following factors is least likely to affect business risk?

A) Demand variability.

B) Operating leverage.

C) Interest rate variability.

Q5. Hughes Continental is assessing its business risk. Which of the following factors would least likely be considered in the analysis?

A) Debt-equity ratio.

B) Input price variability.

C) Unit sales levels.

Q6. Financial risk is borne by:

A) common shareholders.

B) creditors.

C) managers.

Q7. 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) lower.

B) not enough information.

C) higher.

Q8. The two major types of risk affecting a firm are:

A) financial risk and cash flow risk.

B) business risk and financial risk.

C) business risk and collection risk.

Q9. The uncertainty in return on assets due to the nature of a firm’s operations is known as:

A) business risk.

B) financial leverage.

C) tax efficiency.

Q10. As financial leverage increases, what will be the impact on the expected rate of return and financial risk?