LOS c: Characterize the operating leverage, financial leverage, and total leverage of a company given a description of it.

Q1. 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.

Q2. NG Inc. is thinking about issuing new common stock. Given the following information, what would be NG’s cost of issuing new common stock?

• Beta of common stock = 1.10
• Risk-free rate = 3.5%
• Expected return on the stock market = 8.0%
• Marginal tax rate = 40%

A)   9.60%.

B)   8.45%.

C)   5.10%.

Q3. Financial leverage would NOT be increased if a firm financed its next project with:

A)   common stock.

B)   preferred stock.

C)   bonds with embedded call options.

Q4. 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.

Q5. Which of the following financial statement effects is most likely associated with an increase in financial leverage?

A)   Increased operating expenses.

B)   Increased revenue.

C)   Increased liabilities.

Q6. Which of the following types of firms is most likely to have a high degree of operating leverage?

A)   A firm that develops and sells complex software.

B)   A fine clothing retailer.

C)   A restaurant.

LOS c: Characterize the operating leverage, financial leverage, and total leverage of a company given a description of it. fficeffice" />

Q1. 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.

Correct answer is C)

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.

Q2. NG Inc. is thinking about issuing new common stock. Given the following information, what would be NG’s cost of issuing new common stock?

• Beta of common stock = 1.10
• Risk-free rate = 3.5%
• Expected return on the stock market = 8.0%
• Marginal tax rate = 40%

A)   9.60%.

B)   8.45%.

C)   5.10%.

Correct answer is B)

The cost of common stock can be calculated using the Security Market Line:

r_ce = risk free rate + beta of stock × (market return ? risk free rate)
r_ce = 0.035 + 1.1 × (0.08 ? 0.035)
r_ce = 8.45%

There is no tax savings when issuing new common stock.

Q3. Financial leverage would NOT be increased if a firm financed its next project with:

A)   common stock.

B)   preferred stock.

C)   bonds with embedded call options.

Correct answer is A)

Financial leverage is the result of financing assets with fixed income securities such as bonds or preferred stock. Each of these alternatives has a required payment component that increases the risk of the firm beyond that arising solely from business risk.

Q4. 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.

Correct answer is C)

Acquiring assets by issuing stock decreases the degree of financial leverage since total assets are increased but total liabilities remain the same.

Q5. Which of the following financial statement effects is most likely associated with an increase in financial leverage?

A)   Increased operating expenses.

B)   Increased revenue.

C)   Increased liabilities.

Correct answer is C)

A firm utilizes financial leverage by financing its assets through the use of debt.

Q6. Which of the following types of firms is most likely to have a high degree of operating leverage?

A)   A firm that develops and sells complex software.

B)   A fine clothing retailer.

C)   A restaurant.

Correct answer is A)

Firms that tend to have high operating leverage are those that invest up front to produce a product, but have low variable costs when it comes to distributing the product. A software development firm will have to spend a great deal of money up front to create the software, but the costs of distributing the software will be relatively low. Retailers and restaurants are more likely to have a variable cost structure, which would imply low operating leverage.

[此贴子已经被作者于2009-3-4 10:26:11编辑过]

b

thanks

would like to check the answers