Chapter 12 Determining the Financing Mix

32) Operating leverage has to do with

A) borrowing money to finance a firm's growth.

B) using preferred stock to increase sales volume.

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

D) financing with fixed cost sources of capital.

33) Which of the following statements about operating leverage is true?

A) Operating leverage reduces a firm's risk.

B) Operating leverage is the responsiveness of the firm's EBIT to fluctuations in sales.

C) Operating leverage involves the usage of fixed cost financial securities in the operation of a business.

D) Operating leverage is the responsiveness of the firm's EPS to fluctuations in sales.

34) Financial leverage has to do with

A) the usage of fixed cost financial securities to finance a portion of a firm's assets.

B) using common stock to finance a portion of a firm's assets.

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

D) a high gross profit margin.

35) Which of the following statements about financial leverage is true?

A) Financial leverage is the responsiveness of the firm's EBIT to fluctuations in sales.

B) Financial leverage involves the incurrence of fixed operating costs in the firm's income stream.

C) Financial leverage is the responsiveness of the firm's EPS to fluctuations in EBIT.

D) Financial leverage reduces a firm's risk.

36) Which of the following statements about combined (operating & financial) leverage is true?

A) If a firm employs both operating and financial leverage, any percent change in sales will produce a larger percent change in earnings per share.

B) A firm that is in a capital-intensive industry should use a higher level of financial leverage than a firm that employs low levels of operating leverage.

C) Usage of both operating and financial leverage reduces a firm's risk.

D) High operating leverage and high financial leverage offset one another, meaning that if sales increase by 10%, then EPS will also increase by 10%.

37) The following information pertains to the Classic Burger Restaurant chain:

Sales	$600,000
Variable costs	300,000
Total contribution margin	300,000
Fixed costs	100,000
EBIT	200,000
Interest expense	50,000
Earnings before taxes	150,000
Taxes (30%)	45,000
Net income	$105,000

a. If sales increase by 10%, what will be the new level of EPS if the firm has 100,000 shares outstanding?

b. What is the percentage increase in EPS? Explain the difference between the percentage increase in sales and the percentage increase in EPS.

Learning Objective 4

1) Raising funds internally is effectively increasing the investment of the firm's existing common shareholders.

2) Capital structure is equal to financial structure minus current liabilities.

3) The optimal capital structure occurs when operating leverage equals financial leverage.

4) Higher bankruptcy costs will result in optimal capital structures using more long-term debt financing.