FINANCING DECISION MAKING

Question 1

Define operating leverage

Answer 1

Measures the degree to which a firm builds fixed costs into its operations

High fixed cost and decreased sales means loss

The greater the fixed cost, the greater the business risk.

DOL = Ratio of change in operating income to change in unit sales volume

High DOL
Sales volume increase
Results in substantial increase in net income

Low degree of DOL - less leveraged firms enjoy only small increase in income as sales volume increases

Question 2

Formula for DOL

Answer 2

% change in operating income
____________________
% change in unit volume

Question 3

What is financial leverage?

Answer 3

Measures the extent to which the firm uses debt financing

Less costly but interest rate increases as more debts are issued

More debts - means high financial leverage

Question 4

Advantage/disadvantage of a firm’s debt financing to it’s stockholders

Answer 4

Stockholders get higher returns or earnings per share

Increases risk
Increases interest rate on additional debts

Question 5

Operating leverage

Answer 5

degree of building fixed costs into its operations

Question 6

What is the best and optimal capital structure?

Answer 6

A mixture of debt and equity

Minimum WACC

Question 7

DFL formula

Answer 7

% change in EPS
_____________
% change in EBIT

Question 8

Capital lease requirements

Answer 8

title transfer
bpo at end of lease- very low
lease term 75% or more of life
PV of minimum lease payments 90% or more of FV of leased property

account asset like a purchase
record asset at pv of minimum lease payments
record lease liability
each payment is for interest and principal reduction

Question 9

Sale-leaseback

Answer 9

owner sells the property and simultaneously leases it back from the buyer