Chapter 05 Operating and Financial Leverage: Answer Key
Multiple Choice Questions
42. The concept of operating leverage involves the use of __________ to magnify returns at
high levels of operation.
A. fixed costs
B. variable costs
C. marginal costs
D. semi-variable costs
43.
Which of the following questions does break-even analysis attempt to address?
A. How much do changes in volume affect costs and profits?
B. At what point does the firm break even?
C. What is the most efficient level of fixed assets to employ?
D. All of the options
44.
In break-even analysis, the contribution margin is defined as
A. price minus variable cost.
B. price minus fixed cost.
C. variable cost minus fixed cost.
D. fixed cost minus variable cost.
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45.
At the break-even point, a firm's profits are
A. greater than zero.
B. less than zero.
C. equal to zero.
D. Not enough information is given to determine.
46.
If a firm sells 40,000 units and the contribution margin on the firm's single product is
$4.00 per unit and fixed costs are $60,000, what will the firm's operating profit be at
this level of sales volume?
A. $100,000
B. $30,000
C. $15,000
D. $145,000
48.
The break-even point can be calculated as
A. variable costs divided by contribution margin per unit.
B. total costs divided by contribution margin per unit.
C. variable costs times contribution margin per unit.
D. fixed costs divided by contribution margin per unit.
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49.
A highly automated plant would generally have
A. more variable than fixed costs.
B. more fixed than variable costs.
C. all fixed costs.
D. all variable costs.
50.
If fixed costs rise while other variables stay constant
A. the break-even point rises.
B. the degree of operating leverage increases.
C. total profit declines.
D. All of the options
51.
If the price per unit decreases because of competition but the cost structure remains the
same
A. the break-even point rises.
B. the degree of combined leverage declines.
C. the degree of financial leverage declines.
D. All of the options
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52.
If a firm has fixed costs of $60,000, a price of $7.00, and a break-even point of 25,000
units, the variable cost per unit is _____.
A. $5.00
B. $4.60
C. $5.40
D. $4.00
53.
If a firm has fixed costs of $30,000, a variable cost per unit of $.75, and a break-even
point of 5,000 units, the price is _____.
A. $2.50
B. $6.75
C. $4.00
D. $4.50
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54.
If a firm has a price of $6.00, a variable cost per unit of $4.00, and a break-even point
of 40,000 units, fixed costs are equal to _____.
A. $27,000
B. $90,000
C. $80,000
D. $50,000
57.
A firm's break-even point will rise if
A. fixed costs decrease.
B. contribution margin increases.
C. price per unit rises.
D. variable cost per unit rises.
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58.
Davison Toaster Corp. sells its products for $150 per unit. It has the following costs:
The break-even point is
A. less than 3,000 units.
B. 3,000 units.
C. more than 3,500 units.
D. Not enough information has been provided to determine the break-even point.
60.
A weakness of break-even analysis is that it assumes
A. revenue and costs are a linear (constant) function of volume.
B. prices and costs increase when the economy is strong and confidence is high.
C. the cost of goods sold goes up as revenue increases.
D. None of the options
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61.
A high DOL means
A. there are high labor costs.
B. there is high debt.
C. there is a large amount of equity.
D. there are high fixed costs.
62.
Which of the following is concerned with the change in operating profit as a result of a
change in volume?
A. Financial leverage
B. Break-even point
C. Operating leverage
D. Combined leverage
64.
The degree of operating leverage may be defined as
A. the percent change in operating income divided by the percent change in unit
volume.
B. Q(P - VC) divided by Q(P - VC) - FC.
C. S - TVC divided by S - TVC - FC.
D. All of the options
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66.
Conservatively leveraged Firm C and highly leveraged Firm H operate at the same
level of earnings before interest and taxes where the return on assets is greater than the
cost of debt.
A. Firm C will have a higher return on equity than H.
B. Firm H will have a higher return on equity than C.
C. The return on equity will not be affected by financial leverage.
D. The return on equity will be the same at an equal level of earnings.
67.
The degree of operating leverage is computed as
A. percent change in operating profit divided by percent change in net income.
B. percent change in unit volume divided by percent change in operating profit.
C. percent change in EPS divided by percent change in operating income.
D. percent change in operating income divided by percent change in unit volume.
68.
Firm A employs a high degree of operating leverage; Firm B takes a more conservative
approach. Which of the following comparative statements about firms A and B is true?
A. A has a lower break-even point than B, but A's profit grows faster after the
breakeven.
B. A has a higher break-even point than B, but A's profit grows slower after the
breakeven.
C. B has a lower break-even point than A, but A's profit grows faster after the
breakeven.
D. B has a lower break-even point than A, and profit grows the same rate for both
companies after the break-even point.
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69.
Firms with a high degree of operating leverage are
A. easily capable of surviving large changes in sales volume.
B. usually trading off lower levels of risk for higher profits.
C. significantly affected by changes in interest rates.
D. trading off higher fixed costs for lower per-unit variable costs.
70.
Financial leverage deals with
A. the relationship of fixed and variable costs.
B. the relationship of debt and equity in the capital structure.
C. the entire income statement.
D. the entire balance sheet.
71.
A conservative financing plan involves
A. heavy reliance on debt.
B. heavy reliance on equity.
C. a high degree of financial leverage.
D. a high degree of combined leverage.
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73.
If EBIT equals $200,000 and interest equals $40,000, what is the degree of financial
leverage?
A. 5.33x
B. 1.25x
C. .8125x
D. 4.33x
74.
The degree of financial leverage is concerned with the relationship between
A. changes in volume and changes in EPS.
B. changes in volume and changes in EBIT.
C. changes in EBIT and changes in EPS.
D. changes in EBIT and changes in operating income.
75.
When a firm employs no debt
A. it has a financial leverage of one.
B. it has a financial leverage of zero.
C. its operating leverage is equal to its financial leverage.
D. it will not be profitable.
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76.
If a firm has the lowest possible degree of operating leverage and the lowest possible
degree of financial leverage, then
A. DOL equals 1, and DFL equals 0.
B. DOL equals 0, and DFL equals 1.
C. DOL equals 1, and DFL equals 1.
D. None of the options
77.
Combined leverage is concerned with the relationship between
A. changes in EBIT and changes in EPS.
B. changes in volume and changes in EPS.
C. changes in volume and changes in EBIT.
D. changes in EBIT and changes in net income.
78.
Which of the following is not true about leverage?
A. Operating leverage influences the top half of the income statement, determining
EBIT.
B. Financial leverage deals with the bottom half of the income statement, determining
EPS.
C. Combined leverage utilizes the entire income statement, showing the impact of
change in volume on EBIT.
D. None of the options
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79.
If the business cycle is just beginning its upswing, which firm would you anticipate
would be likely to show the best growth in EPS over the next year? Firm A has high
combined leverage and Firm B has low combined leverage.
A. Firm A
B. Firm B
C. Indifferent between the two
D. It depends on how much financial leverage each firm has.
80.
Refer to the figure above. The degree of operating leverage is _____.
A. 1.40x
B. 1.56x
C. 3.33x
D. 2.22x
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81.
Refer to the figure above. The degree of financial leverage is _____.
A. 1.29x
B. 4.20x
C. 3.50x
D. 1.18x
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82.
Refer to the figure above. The degree of combined leverage is _____.
A. 2.22x
B. 1.90x
C. 2.95x
D. 1.65x
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83.
Refer to the figure above. This firm's break-even point is
A. 445 units.
B. 634 units.
C. 714 units.
D. 180 units.
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84.
Refer to the figure above. The degree of operating leverage (DOL) is _____.
A. 1.62x
B. 1.80x
C. 3.50x
D. 1.40x
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85.
Refer to the figure above. The degree of financial leverage (DFL) is _____.
A. 3.50x
B. 1.40x
C. 1.95x
D. 1.25x
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86.
Refer to the figure above. The degree of combined leverage (DCL) is _____.
A. 3.08x
B. 5.45x
C. 2.25x
D. 6.83x
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89.
Firm A produces semiconductors using highly technical machinery; Firm B is a retail
clothing store. Which of the following comparative statements about firms A and B is
true?
A. A has a lower break-even point than B, but A's profit grows faster after the
breakeven.
B. A has a higher break-even point than B, but A's profit grows slower after the
breakeven.
C. B has a lower break-even point than A, but A's profit grows faster after the
breakeven.
D. B has a lower break-even point than A, and profit grows at the same rate for both
companies after the break-even point.
93.
Green Co. has total assets $400,000, a cost of borrowed funds of 6%, and an EBIT of
$42,500. From a financial break-even perspective, Green Co. is
A. breaking even.
B. lower than the breakeven point.
C. higher than the break-even point.
D. in need of new financing.
If maximum interest expense = $24,000 ($400,000 × 6%), and EBIT = $42,500, the
company must be operating above the break-even point.
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