土豆妮

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) 1.3   1.3

B) 1.6   1.3

C) 1.6   2.0

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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

土豆妮

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

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

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

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.

土豆妮

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) 1.33 1.75

B) 1.20 2.00

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

土豆妮

Which of the following best describes a firm with low operating leverage? A large change in:

A) the number of units a firm produces and sells result in a similar change in the firm’s earnings before interest and taxes.

B) earnings before interest and taxes result in a small change in net income.

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

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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.

土豆妮

Which of the following events would decrease financial leverage?

A) Paying dividends.

B) Issuing debt to purchase assets.

C) Issuing common stock 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.