11.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)           1.3         2.0

D)           1.6         1.3

12.Which of the following is a key determinant of operating leverage?

A)   The competitive nature of the business.

B)   The firm's beta.

C)   The tradeoff between fixed and variable costs.

D)   Level and cost of debt.

13.Financial leverage magnifies:

A)   taxes.

B)   operating income variability.

C)   earnings per share variability.

D)   dividends.

11.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)           1.3         2.0

D)           1.6         1.3

The correct answer was A)

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

12.Which of the following is a key determinant of operating leverage?

A)   The competitive nature of the business.

B)   The firm's beta.

C)   The tradeoff between fixed and variable costs.

D)   Level and cost of debt.

The correct answer was C)

Operating leverage can be defined as the trade off between variable and fixed costs.

13.Financial leverage magnifies:

A)   taxes.

B)   operating income variability.

C)   earnings per share variability.

D)   dividends.

The correct answer was C)

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.