Chapter 12 Determining the Financing Mix

22) ACME, Inc. reported the following income statement for 2009:

Sales	$2,500,000
Variable Costs	900,000
Fixed Operating Costs	700,000
EBIT	900,000
Interest Expense	200,000
EBT	700,000
Taxes (30%)	210,000
Net Income	$490,000
Earnings Per Share	$4.90

If ACME's sales next year increase by 20%, what will ACME's earnings per share be?

A) $5.76

B) $6.45

C) $7.14

D) $7.58

23) ACME, Inc. reported the following income statement for 2009:

Sales	$2,500,000
Variable Costs	900,000
Fixed Operating Costs	700,000
EBIT	900,000
Interest Expense	200,000
EBT	700,000
Taxes (30%)	210,000
Net Income	$490,000
Earnings Per Share	$4.90

If ACME's sales next year increase by 20%, ACME's EBIT will increase

A) 20%, showing no operating leverage.

B) 20%, showing no financial leverage.

C) over 35%, due to operating leverage.

D) over 35%, due to operating leverage and financial leverage.

24) Amalgamated Mining, Inc. has very high operating leverage due to the capital intensive nature of the steel business. The firm's CEO is concerned about the variability in the firm's EPS if sales should drop, and decides to take action. Which of the following will reduce the variability in the firm's EPS for a given change in sales?

A) The CEO may increase the firm's financial leverage and hence reduce the variability by using non-shareholder money to support the business.

B) The CEO may decrease the firm's financial leverage, thus lowering the firm's total leverage.

C) The CEO may increase the firm's total leverage by raising money from the sale of common stock.

D) The CEO may issue more corporate bonds and use the proceeds to pay off short-term liabilities.

25) A Bristal Boats, Inc. reports sales of $4,000,000, variable costs of $500,000, fixed operating costs of $1,250,000, and interest expense of $350,000. The corporation's EBIT is $3,250,000 and its marginal tax rate is 30%. If the corporation is able to increase its sales by 25%, then

A) its EBIT will increase by 25% and its EPS will increase by 25%.

B) its EBIT will increase by more than 25% and its EPS will increase by less than 25%.

C) its EBIT and EPS will both increase, but less than 25% due to fixed costs and taxes.

D) its EBIT will increase by more than 25% and its EPS will increase by more than the percentage increase in EBIT.

26) A firm that uses large amounts of debt financing in an industry characterized by a high degree of business risk would have ________ earnings per share fluctuations resulting from changes in levels of sales.

A) no

B) constant

C) large

D) small

27) Financial leverage could mean financing some of a firm's assets with

A) preferred stock.

B) retained earnings.

C) private equity capital.

D) sales revenues.

28) Financing a portion of a firm's assets with securities bearing a fixed rate of return in hopes of increasing the return to stockholders refers to

A) business risk.

B) financial leverage.

C) operating leverage.

D) combined leverage.

29) Operating leverage refers to

A) financing a portion of the firm's assets with securities bearing a fixed rate of return.

B) the additional chance of insolvency borne by the common shareholder.

C) the incurrence of fixed operating costs in the firm's income stream.

D) a high degree of variable costs of production.

30) Financial leverage is distinct from operating leverage since it accounts for

A) use of debt and preferred stock.

B) variability in fixed operating costs.

C) variability in sales.

D) changes in EBIT.

31) If a firm has no operating leverage and no financial leverage, then a 10% increase in sales will have what effect on EPS?

A) EPS will remain the same.

B) EPS will increase by 10%.

C) EPS will decrease by 10%.

D) EPS will increase by less than 10%.