Chapter 12 Determining the Financing Mix

12) The more fixed-charge securities (such as bonds and preferred stock) the firm employs in its financial structure, the greater its financial leverage.

13) An increase in financial leverage will increase the absolute value of EPS, everything else equal.

14) If a company sells bonds and uses the proceeds to buy back common stock, the company's financial leverage with increase.

15) The presence of debt and/or preferred stock in a firm's financial structure means the firm is using financial leverage.

16) Because fixed costs do not vary with a firm's revenues, firm's with high levels of fixed cost enjoy lower levels of operating risk because their costs are more certain, making budgeting easier.

17) If a firm's production process requires high operating leverage (use of fixed costs), then the firm should finance its assets with debt, so that the cost of capital will be reduced and financing costs will remain fixed.

18) Because financial markets can be extremely volatile, with bond and stock prices changing significantly from day to day, a firm's management has much greater control over the firm's operating leverage than over its financial leverage.

19) All of the following are likely to result in the use of less debt in a company's capital structure EXCEPT

A) desire to maintain financial flexibility.

B) desire to maintain a high credit rating.

C) insufficient internal funds.

D) a decrease in a company's marginal tax rate.

20) Which of the following transactions will lower a company's financial leverage?

A) A mortgage loan is obtained and the proceeds are used to pay off existing short-term debt.

B) Preferred stock is sold and the proceeds are used to pay off existing short-term debt.

C) Common stock is sold and the proceeds are used to pay off existing short-term debt.

D) Short-term debt is obtained to get the company through a period of negative net income and cash flow.

21) Dakota Oil, Inc. reported that its sales and EBIT increased by 10%, but its EPS increased by 30%. The much larger change in earnings per share could be the result of

A) high operating leverage.

B) high financial leverage.

C) a high percentage of credit sale collections from prior years.

D) high fixed costs of production.