Leverage & AC vs VC Flashcards
1
Q
- The percentage change in a firm’s EBIT that results in a 1% change in sales or output is known as the a. degree of combined leverage c. degree of operating leverage b. degree of financial leverage d. degree of business risk
A
c. degree of operating leverage
2
Q
- In the analysis of financial leverage, all of the following are referred to as fixed charges except: a. bond interest c. bank interest b. common stock dividends d. preferred stock dividends
A
b. common stock dividends
3
Q
- The degree of combined leverage is defined as resulting from a given percentage change in the percentage change in earnings per share a. operating costs c. common stock dividends b. interest charges d. sales (or output)
A
d. sales (or output)
4
Q
- The degree of combined leverage is equal to the degree of operating leverage ____ the degree of financial leverage. a. added to b. divided by c. multiplied by d. subtracted from
A
c. multiplied by
5
Q
- A firm that employs a relatively large proportion of debt and preferred stock in its capital structure will have a relatively ____ degree of financial leverage. a. low b. high c. insignificant d. constant
A
b. high
6
Q
- A firm that has a 2.5 DOL (degree of operating leverage) would find that an 8% increase in EBIT would result from a ____ increase in sales. a. 3.2% b. 5.4% c. 20.0% d. 2.0%
A
a. 3.2%
7
Q
- A negative DOL indicates the percentage ____ in operating losses that occurs as the result of a 1% increase in output. a. increase b. reduction c. change d. none of the above
A
b. reduction
8
Q
- The use of increasing amounts of combined leverage ____ the risk of financial distress. a. decreases c. has no effect on b. increases d. creates diversity in
A
b. increases
9
Q
- The degree of financial leverage is defined as the percentage change in a. EBIT resulting from a given percentage change in sales b. EPS resulting from a given percentage changes in sales c. EBIT resulting from a given percentage change in EPS d. EPS resulting from a given percentage change in EBIT
A
d. EPS resulting from a given percentage change in EBIT
10
Q
- The increased variability in earnings per share due to the firm’s use of debt is a definition of ____. a. combined leverage c. financial risk b. agency risk d. operating risk
A
c. financial risk
11
Q
- Illinois Tool Company’s (ITC) fixed operating costs are P1,260,000 and its variable cost ratio (i.e., variable costs as a fraction of sales) is 0.70. The firm has P3,000,000 in bonds outstanding at an interest rate of 8 percent. ITC has 30,000 shares of P5 preferred stock and 150,000 shares of common stock outstanding. ITC is in the 50 percent corporate income tax bracket. Forecasted sales for next year are P9 million. What is ITC’s degree of operating leverage at a sales level of P9 million? a. 1.60 c. 3.0 b. 1.875 d. none of the above
A
b. 1.875
12
Q
- Illinois Tool Company’s (ITC) fixed operating costs are P1,260,000 and its variable cost ratio (i.e., variable costs as a fraction of sales) is 0.70. The firm has P3,000,000 in bonds outstanding at an interest rate of 8 percent. ITC has 30,000 shares of P5 preferred stock and 150,000 shares of common stock outstanding. ITC is in the 50 percent corporate income tax bracket. Forecasted sales for next year are P9 million. What is ITC’s degree of financial leverage at an EBIT level of P1,440,000. a. 1.20 b. 1.875 c. 3.0 d. 1.60
A
d. 1.60
13
Q
- Illinois Tool Company’s (ITC) fixed operating costs are P1,260,000 and its variable cost ratio (i.e., variable costs as a fraction of sales) is 0.70. The firm has P3,000,000 in bonds outstanding at an interest rate of 8 percent. ITC has 30,000 shares of P5 preferred stock and 150,000 shares of common stock outstanding. ITC is in the 50 percent corporate income tax bracket. Forecasted sales for next year are P9 million. What is ITC’s degree of combined leverage at a sales level of P10 million? a. 2.00 c. 2.50 b. 1.72 d. none of the above
A
c. 2.50
14
Q
- Suppose that ITC’s degree of combined leverage (DCL) is 3.00 at a sales volume of P9 million. Determine ITC’s percentage change in earnings per share (EPS) if forecasted sales increase by 20 percent to P10,800,000. a. 60% c. 32% b. 50% d. none of the above
A
a. 60%
15
Q
- The Lincoln Mint produces various types of one ounce silver commemorative medals for sale to collectors. The cost of producing and selling a given medal is as follows: Fixed costs: Design and preparation of dies P 8,000 Promotion and selling expenses 25,000 Administrative overhead 7,000 Total P40,000 Variable costs: Silver blanks P 6.00 Striking medals 0.50 Mailing expenses. 3.50 Total P 10.00 Projected selling price: P14.00 What is the degree of operating leverage at an output level of 15,000 units? a. 0.0 b. 1.0 c. 3.0 d. cannot be computed from information in problem
A
c. 3.0
16
Q
- Kermit’s Hardware’s (KH) fixed operating costs are P20.8 million and its variable cost ratio is 0.30. The firm has P10 million in bonds outstanding with a coupon interest rate of 9%. KH has 200,000 shares of common stock outstanding. The firm has revenues of P32.2 million and its marginal tax rate is 40%. Compute KH’s degree of operating leverage. a. 14.81 b. 5.19 c. 12.95 d. 4.54
A
c. 12.95
17
Q
- Kermit’s Hardware’s (KH) fixed operating costs are P20.8 million and its variable cost ratio is 0.30. The firm has P10 million in bonds outstanding with a coupon interest rate of 9%. KH has 200,000 shares of common stock outstanding. The firm has revenues of P32.2 million and its marginal tax rate is 40%. Compute KH’s degree of financial leverage. a. 1.22 b. 2.07 c. 1.09 d. 1.04
A
b. 2.07
18
Q
- Kermit’s Hardware’s (KH) fixed operating costs are P20.8 million and its variable cost ratio is 0.30. The firm has P10 million in bonds outstanding with a coupon interest rate of 9%. KH has 200,000 shares of common stock outstanding. The firm has revenues of P32.2 million and its marginal tax rate is 40%. Compute KH’s degree of combined leverage. a. 26.8 b. 5.5 c. 29.1 d. 4.7
A
a. 26.8
19
Q
- Weis Products has fixed operating costs of P20 million and a variable cost ratio of 0.55. Weis has 4 million common shares outstanding and a marginal tax rate of 45%. What is Weis’s degree of operating leverage at an expected sales level of P150 million. a. 1.00 b. 1.74 c. 1.42 d. 1.32
A
c. 1.42
20
Q
- Kenzel has an EPS of P4.20 and sales are P9 million. If the firm has a degree of operating leverage of 4.0 and a degree of financial leverage of 5.2, forecast EPS if the firm expects a 4% sales decline. a. P0.71 b. P3.49 c. P4.03 d. P3.33
A
a. P0.71
21
Q
- As more debt is added to the capital structure of a firm, the cost of debt capital a. initially rises slowly, then falls beyond some point b. increases at a steady rate throughout the entire range c. beyond some point, becomes greater than the cost of equity d. initially rises slowly, then increases rapidly beyond some point
A
d. initially rises slowly, then increases rapidly beyond some point
22
Q
- The mix of debt, preferred stock, and common equity that minimizes the weighted cost of capital to the firm is known as the a. optimal corporate structure c. optimal capital structure b. target financial structure d. optimal degree of combined leverage
A
c. optimal capital structure
23
Q
- Generallythe____afirm’sbusinessrisk,the____theamountoffinancialleveragethatwill be used in the optimal capital structure. a. greater, greater c. greater, less b. smaller, less d. none of the above is correct
A
c. greater, less
24
Q
- The objective of capital structure management is to find the capital mix that leads to a. maximization of earnings per share b. shareholder wealth maximization c. maximization of net income d. maximization of the current period’s dividends
A
b. shareholder wealth maximization
25
Q
- Agency costs a. increase as the debt/total assets ratio decreases b. affect the present value of the tax shield c. decrease as financial distress increases d. reduce the market value of the levered firm
A
d. reduce the market value of the levered firm
26
Q
- Investors’ required returns and the cost of equity capital ____ as the relative amount of debt used to finance the firm ____. a. increase, increases c. remain constant, increases b. increase, decreases d. remain constant, decreases
A
a. increase, increases
27
Q
- According to the “pecking order theory,” firms prefer to issue ____ securities first and then issue ____ securities as a last resort. a. equity, debt c. debt, equity b. debt, convertible debt d. equity, convertible debt
A
c. debt, equity
28
Q
- ____referstotheargumentthatofficersandmanagershaveaccesstoinformationaboutthe expected future earnings of the firm that is not available to outside investors. a. Insider trading c. Signaling effect b. Asymmetric information d. Pecking order theory
A
b. Asymmetric information
29
Q
- A firm with highly liquid assets plus unused debt capacity is said to have ____. a. arbitrage structural capacity b. the optimal capital structure c. financial slack d. optimal financial structure
A
c. financial slack
30
Q
- Calculate the market value of Lotle Group, a firm with total assets of P80 million and P30 million of perpetual debt in its capital structure. The firm’s cost of equity is 14% and the cost of debt is 9%. Lotle expects annual, perpetual net operating income (EBIT) of P9 million and a marginal tax rate of 40%. a. P30 million c. P57 million b. P61.3 million d. P64.3 million
A
c. P57 million
31
Q
- Knight Moves is considering two alternative financing plans. The firm is expected to operate at the P75 million EBIT level. Under Plan D (debt financing) EPS is expected to be P2.25, and under Plan E (equity financing) EPS is expected to be P1.82. If the market is expected to assign a P/E ratio of 12 to the debt plan and 15 to the equity plan, which plan should Knight pursue? a. debt b. equity c. indifferent between the two alternatives d. neither is satisfactory
A
b. equity
32
Q
- Technico has determined that its optimal capital structure is 40% debt, at which point its weighted cost of capital, ka, is 13.7%. Due to financial problems, the firm has decided to raise the proportion of debt to 50%, which will increase its weighted cost of capital to 14.4%. What is the effect on the stock price of Technico? The current dividend is P1.60 and the long-term growth rate of dividends is expected to be 8.5%. a. Decrease P3.65 c. Increase P3.65 b. Decrease P3.96 d. Increase P3.96
A
b. Decrease P3.96
33
Q
- Triad Labs has total assets of P120 million and P40 million of debt in its capital structure. Its current cost of equity is 13% and its cost of debt is 8.5%. Triad is considering increasing its debt to P70 million and purchasing its own stock with proceeds from the sale of P30 million in debt with a cost of 9.5%, reducing equity to P50 million. The cost of equity will increase to 14.5%. Net operating income (EBIT) will remain at P12 million. If Triad has a marginal tax rate of 40%, should the firm increase its debt? Assume that both debt and EBIT are perpetual. a. No, the value of the firm decreases P15.9 million b. No, the value of the firm decreases P30.0 million c. Yes, the value of the firm increases P14.1 million d. Yes, the value of the firm increases P30.0 million
A
c. Yes, the value of the firm increases P14.1 million
34
Q
- Twin City Printing is considering two financial alternatives for financing a major expansion program. Under either alternative EBIT is expected to be P15.6 million. Currently the firm’s capital structure consists of 4 million shares of common stock and P35 million in 11% long- term bonds. Under the debt financing alternative P10 million in 12% long-term bonds will be sold and under the equity financing alternative the firm would sell 500,000 shares of common stock. The P/E under the debt alternative would be 15 and the P/E under the equity alternative would be 16. The firm’s marginal tax rate is 40%. Which alternative would produce the higher stock price? a. debt–stock price of P23.75 c. equity–stock price of P25.07 b. debt–stock price of P32.29 d. equity–stock price of P33.28
A
35
Q
- Another name for absorption costing is a. full costing. c. job order costing b. direct costing. d. fixed costing
A
a. full costing
36
Q
- If a firm produces more units than it sells, absorption costing, relative to variable costing, will result in a. higher income and assets. c. lower income but higher assets. b. higher income but lower assets. d. lower income and assets.
A
. higher income and assets.
37
Q
- Under absorption costing, fixed manufacturing overhead could be found in all of the following except the a. work-in-process account. c. Cost of Goods Sold. b. finished goods inventory account. d. period costs.
A
d. period costs.
38
Q
- If a firm uses absorption costing, fixed manufacturing overhead will be included a. only on the balance sheet. b. only on the income statement. c. on both the balance sheet and income statement. d. on neither the balance sheet nor income statement.
A
c. on both the balance sheet and income statement.
39
Q
- Under absorption costing, if sales remain constant from period 1 to period 2, the company will report a larger income in period 2 when a. period 2 production exceeds period 1 production. b. period 1 production exceeds period 2 production. c. variable production costs are larger in period 2 than period 1. d. fixed production costs are larger in period 2 than period 1.
A
. period 2 production exceeds period 1 production
40
Q
- An ending inventory valuation on an absorption costing balance sheet would a. sometimes be less than the ending inventory valuation under variable costing. b. always be less than the ending inventory valuation under variable costing. c. always be the same as the ending inventory valuation under variable costing. d. always be greater than or equal to the ending inventory valuation under variable costing.
A
d. always be greater than or equal to the ending inventory valuation under variable costing.
41
Q
- Absorption costing differs from variable costing in all of the following except a. treatment of fixed manufacturing overhead. b. treatment of variable production costs. c. acceptability for external reporting. d. arrangement of the income statement.
A
b. treatment of variable production costs.
42
Q
- Which of the following is not associated with absorption costing? a. functional format c. period costs b. gross margin d. contribution margin
A
d. contribution margin
43
Q
- Unabsorbed fixed overhead costs in an absorption costing system are a. fixed manufacturing costs not allocated to units produced. b. variable overhead costs not allocated to units produced. c. excess variable overhead costs. d. costs that cannot be controlled.
A
a. fixed manufacturing costs not allocated to units produced.
44
Q
- Profit under absorption costing may differ from profit determined under variable costing. How is this difference calculated? a. Change in the quantity of all units in inventory times the relevant fixed costs per unit. b. Change in the quantity of all units produced times the relevant fixed costs per unit. c. Change in the quantity of all units in inventory times the relevant variable cost per unit. d. Change in the quantity of all units produced times the relevant variable cost per unit.
A
a. Change in the quantity of all units in inventory times the relevant fixed costs per unit.
45
Q
- What factor, related to manufacturing costs, causes the difference in net earnings computed using absorption costing and net earnings computed using variable costing? a. Absorption costing considers all costs in the determination of net earnings, whereas variable costing considers fixed costs to be period costs. b. Absorption costing allocates fixed overhead costs between cost of goods sold and inventories, and variable costing considers all fixed costs to be period costs. c. Absorption costing “inventories” all direct costs, but variable costing considers direct costs to be period costs. d. Absorption costing “inventories” all fixed costs for the period in ending finished goods inventory, but variable costing expenses all fixed costs.
A
inventories, and variable costing considers all fixed costs to be period costs.
46
Q
- The costing system that classifies costs by functional group only is a. standard costing. c. variable costing. b. job order costing. d. absorption costing.
A
d. absorption costing.
47
Q
- A functional classification of costs would classify “depreciation on office equipment” as a a. product cost. b. general and administrative expense. c. selling expense. d. variable cost.
A
b. general and administrative expense.
48
Q
- The costing system that classifies costs by both functional group and behavior is a. process costing. c. variable costing. b. job order costing. d. absorption costing.
A
c. variable costing.
49
Q
- Under variable costing, which of the following are costs that can be inventoried? a. variable selling and administrative expense b. variable manufacturing overhead c. fixed manufacturing overhead d. fixed selling and administrative expense
A
b. variable manufacturing overhead
50
Q
- Consider the following three product costing alternatives: process costing, job order costing, and standard costing. Which of these can be used in conjunction with variable costing? a. job order costing c. process costing b. standard costing d. all of them
A
d. all of them
51
Q
- Another name for variable costing is a. full costing. c. standard costing b. direct costing. d. adjusting costing
A
b. direct costing.
52
Q
- If a firm uses variable costing, fixed manufacturing overhead will be included a. only on the balance sheet. b. only on the income statement. c. on both the balance sheet and income statement. d. on neither the balance sheet nor income statement.
A
b. only on the income statement.
53
Q
- Undervariablecosting, a. all product costs are variable. c. all product costs are fixed. b. all period costs are variable. d. product costs are both fixed and variable.
A
. all product costs are variable.
54
Q
- How will a favorable volume variance affect net income under each of the following methods? Absorption. Variable a. reduce. No effect b. reduce. Increase c. increase. No effect d. increase. Reduce
A
c. increase. No effect
55
Q
- The difference between the reported income under absorption and variable costing is attributable to the difference in the a. income statement formats. b. treatment of fixed manufacturing overhead. c. treatment of variable manufacturing overhead. d. treatment of variable selling, general, and administrative expenses.
A
b. treatment of fixed manufacturing overhead.
56
Q
- On the variable costing income statement, the difference between the”contribution margin” and “income before income taxes” is equal to a. the total variable costs. b. cost of good sold c. total fixed costs. d. the gross margin.
A
c. total fixed costs.
57
Q
- In the application of “variable costing” as a cost-allocation process in manufacturing, a. variable direct costs are treated as period costs. b. nonvariable indirect manufacturing costs are treated as product costs. c. variable indirect manufacturing costs are treated as product costs. d. nonvariable direct costs are treated as product costs.
A
c. variable indirect manufacturing costs are treated as product costs.
58
Q
- A basic tenet of variable costing is that period costs should be currently expensed. What is the rationale behind this procedure? a. Period costs are uncontrollable and should not be charged to a specific product. b. Period costs are generally immaterial in amount and the cost of assigning the amounts to specific products would outweigh the benefits. c. Allocation of period costs is arbitrary at best and could lead to erroneous decision by management. d. Because period costs will occur whether production occurs, it is improper to allocate these costs to production and defer a current cost of doing business.
A
these costs to production and defer a current cost of doing business.
59
Q
- What costs are treated as product costs under variable (direct) costing? a. only direct costs c. all variable costs b. only variable production costs d. all variable and fixed manufacturing costs
A
d
60
Q
- Which of the following is an argument against the use of direct (variable) costing? a. Absorption costing overstates the balance sheet value of inventories. b. Variable factory overhead is a period cost. c. Fixed manufacturing overhead is difficult to allocate properly. d. Fixed manufacturing overhead is necessary for the production of a product.
A
. Fixed manufacturing overhead is necessary for the production of a product.
61
Q
- Anincomestatementispreparedasaninternalreport.Underwhichofthefollowingmethods would the term contribution margin appear? Absorption costing Variable Costing a. no no b. no yes c. yes no d. yes yes
A
b. no yes
62
Q
- Variable costing has an advantage over absorption costing for which of the following purposes? a. analysis of profitability of products, territories, and other segments of a business b. determining the CVP relationship among the major factors of selling price, sales mix, and sales volume c. minimizing the effects of inventory changes on net income d. all of the above
A
. all of the above
63
Q
- In the variable costing income statement, which line separates the variable and fixed costs? a. selling expenses c. product contribution margin b. general and administrative expense d. total contribution margin
A
d. total contribution margin
64
Q
- A firm presently has total sales of P100,000. If its sales rise, its a. net income based on variable costing will go up more than its net income based on absorption costing. b. net income based on absorption costing will go up more than its net income based on variable costing. c. fixed costs will also rise. d. per unit variable costs will rise.
A
absorption costing.
