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Question #1 of Question ID: 1469208 Government regulators typically require periodic disclosure of a company's financial performance for: A) private companies only B) public companies only C) both private and public companies Explanation Regulators typically require periodic reporting of financial results for public companies Private companies are typically not subject to these requirements (Module 28.1, LOS 28.b) Question #2 of Question ID: 1469206 Under which business structure are profits potentially subject to double taxation? A) Corporation B) General partnership C) Limited partnership Explanation Double taxation refers to a situation in which a country taxes corporations' gross earnings and then taxes net earnings distributed to owners (dividends) as personal income Partnership profits are subject to only one level of taxation (they are personal income of the partners) (Module 28.1, LOS 28.a) Question #3 of Question ID: 1469205 In a partnership, a general partner's liability for the obligations incurred by the business: A) depends on whether the partnership is general or limited B) is unlimited C) is limited to the amount invested Explanation In either a general partnership or a limited partnership, general partners have unlimited liability (Module 28.1, LOS 28.a) Question #4 of Question ID: 1469210 Increasing a company's risk exposure in an effort to increase its growth rate is most likely to be favored by: A) owners but not lenders B) both lenders and owners C) neither lenders nor owners Explanation Because the upside for lenders is limited to the promised interest payments and repayment of principal, they not benefit from an increased growth rate of the company and are unlikely to favor actions that increase a company's risk exposure and potential for default Because owners have potentially unlimited upside from a company's growth, they are more likely to favor actions that increase a company's potential growth rate (Module 28.1, LOS 28.c) Question #5 of Question ID: 1469204 The owner's liability for the business obligations of a sole proprietorship: A) is limited to the amount invested B) may be limited or unlimited C) is unlimited Explanation A sole proprietorship is legally an extension of the individual who owns and operates it The owner has unlimited liability for obligations the business incurs (Module 28.1, LOS 28.a) Question #6 of Question ID: 1469207 A corporation that wishes to raise equity capital and have its shares publicly traded is most likely to engage in: A) a management buyout B) an initial public offering C) a direct listing on an exchange Explanation An initial public offering is a sale of equity shares to the public Proceeds from the sale increase the issuer's equity capital A direct listing does not raise capital A management buyout is a method to take a public company private (Module 28.1, LOS 28.b) Question #7 of Question ID: 1469209 Which of the following payments are contractual obligations of a corporation? A) Interest and principal payments B) Interest and common stock dividend payments C) Interest, principal, and preferred stock dividend payments Explanation Interest and principal payments to lenders are contractual obligations A corporation may distribute dividends to owners but is not required to so (Module 28.1, LOS 28.c) Question #1 of 13 Question ID: 1463546 In the absence of any ESG-related constraints specified in an investment policy statement, a portfolio manager is most likely to violate fiduciary duty by using ESG factors to: A) assess the expected return and risk of potential portfolio investments B) exclude investments with negative ESG characteristics from the investor’s portfolio C) choose among investments with similar risk and return characteristics Explanation Constructing a portfolio based on ESG factors may violate fiduciary duty if doing so reduces expected returns Analyzing ESG factors when assessing investment risk or using ESG factors to choose among otherwise equivalent investments would likely not violate fiduciary duty (Module 29.2, LOS 29.e) Question #2 of 13 Question ID: 1463543 Smith Company's board of directors assigns responsibilities to several committees The committee that is most likely to be responsible for establishing the chief executive officer's compensation package is Smith's: A) governance committee B) remuneration committee C) risk committee Explanation Compensation for a company's senior executives is typically a responsibility of a remuneration or compensation committee (Module 29.1, LOS 29.c) Question #3 of 13 Question ID: 1463544 Responsibilities of a board of directors' nominations committee are least likely to include: A) recruiting qualified members to the board B) evaluating the independence of directors C) selecting an external auditor for the company Explanation Selecting an external auditor (subject to shareholder approval) is a responsibility of the Board's audit committee (Module 29.1, LOS 29.c) Question #4 of 13 Question ID: 1463542 Special resolutions that require a supermajority of shareholder votes may be addressed: A) at either the annual general meeting or an extraordinary general meeting B) only at an extraordinary general meeting C) only at the annual general meeting Explanation Special resolutions may be voted on at the annual general meeting or at an extraordinary general meeting that is called specifically to address them (Module 29.1, LOS 29.c) Question #5 of 13 Question ID: 1463541 A principal-agent relationship most likely exists between a company's: A) shareholders and managers B) directors and regulators C) customers and suppliers Explanation The relationship between shareholders and managers is a principal-agent relationship Shareholders, as principals, through the board of directors hire managers, as agents, to act in the best interests of the shareholders (Module 29.1, LOS 29.b) Question #6 of 13 Question ID: 1463537 The interests of community groups affected by a company's operations are most likely to be considered in corporate governance under: A) special interest theory B) shareholder theory C) stakeholder theory Explanation Community groups may be one of the stakeholder groups considered under stakeholder theory (Module 29.1, LOS 29.a) Question #7 of 13 Question ID: 1463538 Under shareholder theory, corporate governance is most concerned with managing conflicts of interest between the firm's managers and its: A) customers B) owners C) employees Explanation Under shareholder theory, corporate governance is most concerned with managing conflicts of interest between the firm's managers and its owners (shareholders) (Module 29.1, LOS 29.a) Question #8 of 13 Question ID: 1463547 Environmental, social, and governance (ESG) investing is most accurately described as: A) integrating environmental and social considerations into the investment decision making process B) C) investing only in companies that promote environmental or social initiatives favored by an investor excluding companies from consideration for investment based on environmental or social considerations Explanation ESG investing is using environmental, social, and governance factors when making investment decisions Investing only in companies that promote environmental or social initiatives favored by an investor is best described as impact investing Excluding companies from consideration for investment based on environmental or social considerations is best described as negative screening Impact investing and negative screening are two of the approaches an investor can use to implement ESG investing (Module 29.2, LOS 29.e) Question #9 of 13 Question ID: 1463545 Risks that may arise from ineffective corporate governance least likely include: A) reduced default risk B) less effective decision making C) weaker financial performance Explanation Ineffective corporate governance is likely to increase default risk (Module 29.2, LOS 29.d) Question #10 of 13 Question ID: 1463539 The stakeholders of a company that are least likely to prefer a relatively riskier company strategy that has the potential for superior company performance are: A) shareholders B) creditors C) suppliers Explanation A company's creditors prefer less risk because their potential gains from superior company performance are limited, while they have significant downside risk from poor performance that could threaten the company's solvency Shareholders have the greatest gains from superior company performance Suppliers may benefit from superior performance of a company to which they supply goods and services, but in general they prefer stable business operations and continuation of their business relationship with the company (Module 29.1, LOS 29.a) Question #11 of 13 Question ID: 1463536 The stakeholder theory of corporate governance is primarily focused on: A) the interests of various stakeholders rather than the interests of shareholders B) resolving the competing interests of those who manage companies and other groups affected by a company’s actions C) increasing the value a company Explanation Resolving the conflicting interests of both shareholders and other stakeholders is the focus of corporate governance under stakeholder theory Shareholders are among the groups whose interests are considered under stakeholder theory (Module 29.1, LOS 29.a) Question #12 of 13 Question ID: 1463540 The stakeholder group that typically prefers the greatest amount of business risk is: A) directors B) shareholders C) senior managers Explanation Compared to the other two groups, shareholders have the greatest potential gains from riskier strategies and can diversify their holdings across firms in order to reduce the influence of company specific risk While senior managers can gain from company outperformance, they typically prefer less risk than shareholders because managers' risk of poor company performance on the value of their options and on their careers cannot be easily diversified away (Module 29.1, LOS 29.a) Question #13 of 13 Question ID: 1463548 Thematic investing is most accurately described as: A) identifying the best companies in each sector with respect to environmental and social factors B) considering a single environmental or social factor when selecting investments C) excluding companies or sectors from consideration for investment based on environmental and social factors Explanation Thematic investing refers to selecting investments with a view to a specific environmental, social, or governance factor Identifying the best companies in each sector with respect to environmental and social factors is referred to as best-in-class investing Excluding companies or sectors from consideration for investment based on environmental and social factors is referred to as negative screening (Module 29.2, LOS 29.f) Question #1 of Question ID: 1469215 A firm is least likely to reduce its capital needs by adopting which of the following business models? A) Asset-light B) Bundling C) Pay-in-advance Explanation Bundling is a pricing strategy for multiple products Firms that rent or lease major assets (an asset-light model) or receive cash before providing goods or services (a pay-in-advance model) tend to have less need for capital than firms that own fixed assets or not collect cash in advance (Module 30.1, LOS 30.b) Question #2 of Question ID: 1469214 Nebrid Company describes itself as a B2B firm This means that Nebrid: A) is a marketplace for buyers and sellers B) provides both inbound and outbound logistics C) sells its products or services to other businesses Explanation B2B businesses are those that sell their products to other businesses (Module 30.1, LOS 30.a) Question #3 of An example of macro risk that companies may face is: A) exchange-rate risk B) ESG risk Question ID: 1469216 First, calculate the operating results: Opstalan Annual Operating Results Sales $5,000,000 – Variable Costs1 2,000,000 Contribution Margin 3,000,000 – Fixed Costs 1,000,000 EBIT 2,000,000 – Interest Expense EBT = Earnings 1Variable 105,000 1,895,000 costs = 0.40 × 5,000,000 Second, calculate DOL = (Sales – Variable Costs) / (Sales – Variable Costs – Fixed Costs) = 3,000,000 / 2,000,000 = 1.50 Third, calculate DFL = EBIT / (EBIT – I) = 2,000,000 / 1,895,000 = 1.06 Finally, calculate DTL = DOL × DFL = 1.50 × 1.06 = 1.59 (Module 35.1, LOS 35.b) Question #12 of 42 Question ID: 1458018 Which of the following best describes a firm with low operating leverage? A large change in: A) the number of units a firm produces and sells result in a similar change in the firm’s earnings before interest and taxes B) earnings before interest and taxes result in a small change in net income C) sales result in a small change in net income Explanation Operating leverage is the result of a greater proportion of fixed costs compared to variable costs in a firm's capital structure and is characterized by the sensitivity in operating income (earnings before interest and taxes) to change in sales A firm that has equal changes in sales and operating income would have low operating leverage (the least it can be is one) Note that the relationship between operating income and net income is impacted by the degree of financial leverage, and the relationship between sales and net income is impacted by the degree of total leverage (Module 35.1, LOS 35.b) Question #13 of 42 Question ID: 1458014 Stromburg Corporation's sales are $75,000,000 Fixed costs, including research and development, are $40,000,000, while variable costs amount to 30% of sales Stromburg plans an expansion which will generate additional fixed costs of $15,000,000, decrease variable costs to 25% of sales, and permit sales to increase to $100,000,000 What is Stromburg's degree of operating leverage at the new projected sales level? A) 3.50 B) 3.75 C) 4.20 Explanation Sales = $100,000,000 VC of 25% of sales = 25,000,000 FC of 40,000,000 + 15,000,000 = 55,000,000 DOL= [100,000,000 – 25,000,000] / [100,000,000 – 25,000,000 – 55,000,000] = 3.75 (Module 35.1, LOS 35.b) Question #14 of 42 Question ID: 1458030 Annual fixed costs at King Mattress amount to $325,000 The variable cost of raw materials and labor is $120 for the typical mattress Sales prices for mattresses average $160 How many units must King Mattress sell to break even? A) 8,125 B) 2,708 C) 40 Explanation At the breakeven quantity of sales, the contribution margin (price minus variable cost to produce a unit) from the quantity a firm sells just covers its fixed costs: QBreakeven × (Price – Variable Cost) = Fixed Cost Therefore: QBreakeven = Fixed Cost / (Price – Variable Cost) QBreakeven = $325,000 / ($160 – $120) = 8,125 units (Module 35.1, LOS 35.d) Question #15 of 42 Question ID: 1458028 Jayco, Inc has a division that makes red ink for the accounting industry The unit has fixed costs of $10,000 per month, and is expected to sell 40,000 bottles of ink per month If the variable cost per bottle is $2.00 what price must the division charge in order to breakeven? A) $2.25 B) $2.50 C) $2.75 Explanation 40,000 = $10,000/(P - $2) 40,000P – $80,000 = $10,000 P = $90,000/40,000 = $2.25 (Module 35.1, LOS 35.d) Question #16 of 42 Question ID: 1458027 Wanton's San Y'isidro Co manufactures custom door knobs for international clients Average Revenue is $35 per unit, variable costs are $15 per unit, and total costs are $200,000 If sales are 10,000 units, what is the firm's breakeven sales quantity? A) 1,750 units B) 2,500 units C) 3,000 units Explanation For this problem you need equations Break-even quantity = Fixed Costs / (Price - Variable cost) Q = FC / (P - V) Fixed Costs = Total Costs - Variable Costs FC = TC - VC = 200,000 - 150,000 = 50,000 Q = 50,000 / (35 - 15) = 2,500 (Module 35.1, LOS 35.d) Question #17 of 42 Question ID: 1462864 Business risk is best described as resulting from the combined effects of a firm's: A) financial risk and sales risk B) sales risk and operating risk C) operating risk and financial risk Explanation Business risk is the combination of sales risk, which is the variability of a firm's sales, and operating risk, which is the additional variability in operating earnings (EBIT) caused by fixed operating costs (Module 35.1, LOS 35.a) Question #18 of 42 Question ID: 1458003 The two major types of risk affecting a firm are best described as: A) business risk and collection risk B) business risk and financial risk C) financial risk and cash flow risk Explanation The two major types of risk affecting a firm are business risk and financial risk Business risk is the uncertainty regarding the operating income of a company Financial risk refers to the uncertainty caused by the fixed cost associated with borrowed money (Module 35.1, LOS 35.a) Question #19 of 42 Question ID: 1458006 Myron Jackson is a private equity fund manager specializing in distressed companies His investment philosophy is based on the principle that capital structure problems can be fixed, but industry characteristics dictate business models Jackson would most likely be interested in distressed firms with which of the following characteristics? A) High financial risk and low operating risk B) High operating risk and low financial risk C) High operating risk and high financial risk Explanation Financial risk refers to the capital structure, while operating risk refers to the operating cost structure A firm's capital structure is well within the control of management as to how much debt to assume In contrast, a firm's operating cost structure is usually driven by industry characteristics This distressed firm's specialist would be looking for firms with capital structure problems that can be solved with an increase in equity capital and a reduction in debt financing Changing the operating characteristics of the industry is far more challenging (Module 35.1, LOS 35.a) Question #20 of 42 Question ID: 1458022 Additional debt should be used in the firm's capital structure if it increases: A) firm earnings B) earnings per share C) the value of the firm Explanation The key to finding the optimal capital structure is identifying the level of debt that will maximize firm value Earnings and earnings per share are not critical in and of themselves when assessing firm value, because they not consider risk (Module 35.1, LOS 35.c) Question #21 of 42 Question ID: 1458037 Steven's Bakery produces snack cakes and bread Listed below are the operating costs for the snack cakes division and the bread division Snack cakes Bread Price per package $2.00 $2.50 Variable cost per package $1.00 $1.30 Fixed operating costs $25,000 $30,000 Fixed financing costs $10,000 $10,000 Compared to the snack cakes division, the operating breakeven quantity for the bread division is: A) less B) greater C) the same Explanation The operating breakeven quantity for the snack cakes division is $25,000/($2.00 – $1.00) = 25,000 The operating breakeven quantity for the bread division is $30,000/($2.50 – $1.30) = 25,000 (Module 35.1, LOS 35.e) Question #22 of 42 Question ID: 1458001 Hughes Continental is assessing its business risk Which of the following factors would least likely be considered in the analysis? A) Debt-equity ratio B) Input price variability C) Unit sales levels Explanation The main factors affecting business risk are demand variability, sales price variability, input price variability, ability to adjust output prices, and operating leverage Debt levels affect financial risk, not business (operating) risk (Module 35.1, LOS 35.a) Question #23 of 42 Question ID: 1458004 The additional risk a firm's common shareholders must bear when a firm uses fixed cost financing is best described as: A) financial risk B) business risk C) operating risk Explanation When a company finances its operations with fixed cost financing (debt), it takes on fixed expenses in the form of interest payments The greater the proportion of debt in a firm's capital structure, the greater the firm's financial risk Business risk refers to the risk associated with a firm's operating income Operating risk refers to the additional uncertainty about operating earnings caused by fixed operating costs (Module 35.1, LOS 35.a) Question #24 of 42 Variability in a firm's operating income is most closely related to its: A) financial risk B) internal risk C) business risk Explanation Question ID: 1457999 Business risk is the uncertainty regarding the operating income of a company Financial risk refers to the uncertainty caused by the fixed cost associated with borrowed money (Module 35.1, LOS 35.a) Question #25 of 42 Question ID: 1458012 Which of the following statements about leverage is most accurate? A) B) C) If the company has no debt outstanding, then its degree of total leverage equals its degree of operating leverage An increase in fixed costs (holding sales and variable costs constant) will reduce the company's degree of operating leverage A decrease in interest expense will increase the company's degree of total leverage Explanation If debt = then DFL = because DFL = EBIT/(EBIT - I) If debt = then I = and DFL = EBIT/(EBIT - 0) = EBIT/EBIT = DTL = (DOL)(DFL) If DFL = then DTL = (DOL)(1) which complies to DTL = DOL A decrease in interest expense will decrease DFL, which will decrease DTL An increase in fixed costs will increase the company's DOL (Module 35.1, LOS 35.b) Question #26 of 42 Question ID: 1458000 Which of the following factors is least likely to affect business risk? A) Operating leverage B) Demand variability C) Interest rate variability Explanation Business risk can be defined as the uncertainty inherent in a firm's return on assets (ROA) While changes in interest rates may impact the demand or input prices, there is a more direct impact on business risk with the other two choices (Module 35.1, LOS 35.a) Question #27 of 42 Question ID: 1458024 Which of the following is a key determinant of operating leverage? A) Level and cost of debt B) The tradeoff between fixed and variable costs C) The competitive nature of the business Explanation Operating leverage can be defined as the trade off between variable and fixed costs (Module 35.1, LOS 35.c) Question #28 of 42 Question ID: 1458016 All else equal, which of the following statements about operating leverage is least accurate? A) Firms with high operating leverage experience greater variance in operating income B) Lower operating leverage generally results in a higher expected rate of return C) Operating leverage reflects the tradeoff between variable costs and fixed costs Explanation Operating leverage is the trade off between fixed and variable costs Higher operating leverage typically is indicative of a firm with higher levels of risk (greater income variance) Given the positive risk/return relationship, higher operating leverage firms are expected to have a higher rate of return And, lower operating leverage firms are expected to have a lower rate of return (Module 35.1, LOS 35.b) Question #29 of 42 Question ID: 1458002 Which of the following sources of financing is least likely to increase a firm's financial risk? A) Common equity B) Operating leases C) Fixed-rate debt Explanation Financial risk, in the context of a firm's financing of its operations, results from taking on fixed financial obligations such as debt or operating leases Common equity financing does not involve fixed obligations (Module 35.1, LOS 35.a) Question #30 of 42 Question ID: 1458023 Financial leverage magnifies: A) taxes B) earnings per share variability C) operating income variability Explanation Financial leverage results in the existence of required interest payments and, hence, increased earnings per share variability Higher debt ratios, given a fixed asset base, result in a greater earnings per share variability Operating income is based on the products and assets of the firm and not on the firm's financing and, hence, has no impact on financial leverage Greater financial leverage is likely to reduce taxes due to the tax deductibility of interest payments (Module 35.1, LOS 35.c) Question #31 of 42 Question ID: 1462867 Daley Company sells its output for $15 per unit Daley's variable costs, including taxes, are $10 per unit and its breakeven quantity of sales is 30,000 units Daley's annual fixed costs are $50,000 for interest and $100,000 for rent If Daley sells 35,000 units in a year, its net income will be: A) $25,000 B) $15,000 C) $35,000 Explanation The contribution of each unit sold to covering fixed costs is $15 − $10 = $5 Because selling 30,000 units just covers fixed costs, each additional unit sold produces a profit of $5 Profit is (35,000 − 30,000) × $5 = $25,000 (Module 35.1, LOS 35.d) Question #32 of 42 Question ID: 1458029 Annah Korotkin is the sole proprietor of CoverMeUp, a business that designs and sews outdoor clothing for dogs Each year, she rents a booth at the regional Pet Expo and sells only blankets Korotkin views the Expo as primarily a marketing tool and is happy to breakeven (that is, cover her booth rental) For the last years, she has sold exactly enough blankets to cover the $750 booth rental fee This year, she decided to make all blankets for the Expo out of high-tech waterproof/breathable material that is more expensive to produce, but that she believes she can sell for a higher profit margin Information on the two types of blankets is as follows: Per Unit Last Year's (Basic) Blanket This Year's (New) Blanket Sales Price $25 $40 Variable Cost $20 $33 Assuming that Korotkin remains most interested in covering the booth cost (which has increased to $840), how many more or fewer blankets (new style) does she need to sell to cover the booth cost? To cover this year's booth costs, Korotkin needs to sell: A) 30 fewer blankets than last year B) 42 fewer blankets than last year C) 42 more blankets than last year Explanation To obtain this result, we need to calculate Last Year's Breakeven Quantity, This Year's Breakeven Quantity, and calculate the difference Step 1: Determine Last Year's (Basic Blanket) breakeven quantity: QBE = (Fixed Costs) / (Sales Price per unit – Variable Cost per unit) = 750 / (25 – 20) = 150 Step 2: Determine This Year's (New Blanket) breakeven quantity: QBE = (Fixed Costs) / (Sales Price per unit – Variable Cost per unit) = 840 / (40 – 33) = 120 Step 3: Determine Change in Units: ΔQ = QThis Year – QLast Year = 120 – 150 = –30 Korotkin needs to sell 30 fewer blankets (Module 35.1, LOS 35.d) Question #33 of 42 Question ID: 1457998 Which of the following statements about business risk and financial risk is least accurate? A) Business risk is the riskiness of the company's assets if it uses no debt B) The greater a company's business risk, the higher its optimal debt ratio C) Factors that affect business risk are demand, sales price, and input price variability Explanation The greater a company's business risk, the lower its optimal debt ratio (Module 35.1, LOS 35.a) Question #34 of 42 Question ID: 1458035 Yangtze Delta High Technology produces multimedia-enabled wireless phones The factory incurs rent, depreciation, salary, and other fixed costs totaling RMB 10 million per year Also, the company incurs annual interest of RMB million on debt Each phone sold by Yangtze Delta sells for RMB 200 The variable cost per phone is RMB 150 Yangtze Delta's operating breakeven quantity of sales is closest to: A) 65,000 B) 260,000 C) 200,000 Explanation The operating breakeven point is the quantity of product sold at which operating income is zero (revenue equals operating cost) F = Fixed operating cost = RMB 10,000,000 P = Price per unit = RMB 200 V = Variable cost per unit = RMB 150 Operating breakeven quantity = F / (P – V) = 10,000,000 / (200 – 150) = 200,000 (Module 35.1, LOS 35.e) Question #35 of 42 Question ID: 1462870 Gordon Castparts has fixed operating costs of $1.2 million and fixed financing costs of $400,000 If the price per unit is $39 and variable costs are $22 per unit, Gordon's operating breakeven quantity of sales is closest to: A) 54,500 B) 70,600 C) 94,100 Explanation Operating breakeven quantity of sales = 1.2 million/(39 – 22) = 70,588 units (Module 35.1, LOS 35.e) Question #36 of 42 Question ID: 1462863 Operating risk is most likely to increase as a result of: A) an increase in fixed production costs B) an increase in sales risk C) increased variability of costs Explanation Operating risk refers to uncertainty about operating earnings arising from fixed production (operating) costs (Module 35.1, LOS 35.a) Question #37 of 42 Question ID: 1458005 Business risk is most accurately described as: A) another term for sales risk B) another term for operating risk C) consisting of both sales risk and operating risk Explanation Business risk is the combination of sales risk and operating risk Business risk refers to the risk associated with a firm's operating income and is the result of uncertainty about a firm's revenues and the expenditures necessary to produce those revenues Sales risk is the uncertainty about the firm's sales Operating risk refers to the additional uncertainty about operating earnings caused by fixed operating costs The greater the proportion of fixed costs to variable costs, the greater a firm's operating risk (Module 35.1, LOS 35.a) Question #38 of 42 Question ID: 1458017 An analyst has gathered the following expenditure information for three different firms, each of which has a sales level of $4 million Costs for firms under consideration (in millions) Firm A Firm B Firm C Variable Costs $2.00 $2.60 $2.40 Fixed Costs $1.00 $1.30 $1.40 Interest Expense $0.20 $0.00 $0.20 Which firm has the highest degree of operating leverage (DOL)? A) Firm B B) Firm A C) Firm C Explanation The DOL for the three companies is as follows: DOL = (Total Revenue - Total Variable Costs) / (TR – TVC – Total Fixed Costs) Firm A: ($4.00 – $2.00) / ($4.00 – $2.00 – $1.00) = Firm B: ($4.00 – $2.60) / ($4.00 – $2.60 – $1.30) = 14 Firm C: ($4.00 – $2.40) / ($4.00 – $2.40 – $1.40) = (Note: Interest expense does not affect operating leverage.) (Module 35.1, LOS 35.b) Question #39 of 42 Question ID: 1458015 Which of the following statements regarding leverage is most accurate? A) B) C) A firm with low operating leverage has a small proportion of its total costs in fixed costs A firm with high business risk is more likely to increase its use of financial leverage than a firm with low business risk High levels of financial leverage increase business risk while high levels of operating leverage will decrease business risk Explanation A firm with high operating leverage has a high percentage of its total costs in fixed costs (Module 35.1, LOS 35.b) Question #40 of 42 Question ID: 1462868 First Choice, Inc., sold 40,000 units during its most recent quarter; had fixed operating costs of $70,000, total variable costs of $140,000, and interest expense of $80,000; and charged a price of $7.75 per unit First Choice's breakeven level of sales, based on these values, is closest to: A) 16,500 B) 28,000 C) 35,000 Explanation Variable cost per unit is 140,000 / 40,000 = $3.50 Breakeven level of sales = 70,000+80,000 7.75−3.50 = 35,294 (Module 35.1, LOS 35.d) Question #41 of 42 Question ID: 1458009 During a period of expansion in the economy, compared to firms with lower operating leverage, earnings growth for firms with high operating leverage will be: A) lower B) higher C) unaffected Explanation If a high percentage of a firm's total costs are fixed, the firm is said to have high operating leverage High operating leverage, other things held constant, means that a relatively small change in sales will result in a large change in operating income Therefore, during an expansionary phase in the economy a highly leveraged firm will have higher earnings growth than a lesser leveraged firm The opposite will happen during an economic contraction (Module 35.1, LOS 35.b) Question #42 of 42 Question ID: 1458011 If a 10% increase in sales causes earnings per share to increase from $1.00 to $1.50, and if the firm has no debt, then what is its degree of operating leverage? A) 4.2 B) 5.0 C) 4.7 Explanation The percentage change in earnings that results from a 1% change in sales is a firm's degree of total leverage Here, the percent change in EPS is ($1.50 / $1.00) – = 50%, and DTL = %ΔEPS / %ΔSales = 50% / 10% = 5.0 Because this firm has no debt, its degree of financial leverage is 1.0 and its degree of total leverage equals its degree of operating leverage, which must also be 5.0 (Module 35.1, LOS 35.b) ... Ferryville''s cost of debt capital is closest to: A) 4.4 % B) 2.4% C) 4.9 % Explanation Ferryville''s cost of debt capital is kd(1 - t) = 6.8% × (1 - 0.35) = 4.4 2% Note that the beforetax cost of debt is... assumptions, including the absence of taxes and bankruptcy costs, the value of a firm is unaffected by its capital structure (Module 34.1 , LOS 34.c) Question #5 of 12 Question ID: 1457995 Which... uncommitted line of credit, a bank extends an offer of credit for a certain amount but may refuse to lend if circumstances change With a regular or committed line of credit, a bank extends an offer of