Lab 6 Questions for Chapter 14 – Breakeven, DOL, DFL, DTL
5.
Financial leverage is a direct function of the ratio of
a. EAT to sales.
d. EAT to the number of shares of common
b. EBIT to sales.
stock.
c. interest expense to EBIT.
17.
Which of the following is correct
a. the variation in ROE and EPS for an unleveraged firm is identical to variation in EBIT
b. in a leveraged firm, the variation in ROE and EPS is always greater than the variation in
EBIT
c. financial risk is the additional variation in ROE and EPS arising from the use of debt
d. all of the above
18.
The use of fixed cost sources of funds, such as debt and preferred stock affect a firm's
a. financial risk.
c. market power.
b. degree of operating leverage.
d. business risk.
19.
The increased variability in earnings per share due to the use of debt is
a. combined leverage.
d. operating risk.
b. business risk.
c. financial risk.
22.
If a firm's EBIT changes by 20% and it has a degree of financial leverage (DFL) of 2.5, what is
the expected change in earnings per share (EPS)?
a. 20%
c. 50%
b. 40%
d. 60%
23.
A firm that employs a relatively large proportion of debt in its capital structure will have a
relatively ______ degree of financial leverage.
a. low
c. insignificant
b. high
d. constant
26.
The degree of operating leverage is measured by relating the percentage change in EBIT to the
percentage change in
a. sales.
c. debt ratio.
b. earnings per share.
d. share price.
27.
Operating leverage involves the use of
a. equity and debt in equal proportions.
c. debt.
b. market power.
d. fixed costs.
28.
When a firm's cost structure consists principally of fixed costs:
a. it is said to have a great deal of operating leverage
b. those costs consist of rent, depreciation, direct labor, management salaries, direct
materials, and utilities.
c. the firm might be a factory with many people and few machines
d. all of the above
30.
The process of evaluating a firm's operations to determine the minimum volume it must sell to
avoid losing money is referred to as:
a. operating leverage analysis
c. breakeven analysis
b. direct analysis of operations
d. cost, volume, and profit analysis
32.
When fixed operating costs are incurred by the firm, a relative change in ______ is magnified
into a larger relative change in earnings before interest and taxes.
a. overhead expenses
c. labor costs
b. interest charges
d. sales revenue
33.
A firm that employs relatively large amounts of labor-saving equipment in its operations
will have a relatively ______ degree of operating leverage.
a. low
c. insignificant
b. constant
d. high
1
39.
A decrease in the level of a firm's interest expense (holding all other factors constant) would
a. increase operating leverage.
d. have no impact on operating leverage.
b. decrease operating leverage.
e. c and d
c. decrease financial leverage.
40.
The variability in a firm's EPS is affected by
a. variability in its sales.
d. a and c
b. operating leverage.
e. all of the above
c. financial leverage.
41.
Financial leverage amplifies relative changes in EBIT into larger relative changes in ROE and EPS,
operating leverage amplifies:
a. relative changes in EBIT into larger relative changes in sales revenue
b. relative changes in sales revenue into larger relative changes in EBIT
c. relative changes in sales revenue into larger relative changes in ROE and EPS
d. relative changes in ROE and EPS into larger relative changes in EBIT
46.
If a firm's sales change by 15% and it has a degree of operating leverage (DOL) of 2.0, what is the
expected change in earnings before interest and taxes (EBIT)?
a. 30%
c. 50%
b. 40%
d. 60%
47.
A firm which 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%
c. 20.0%
b. 5.4%
d. 2.0%
42.
The degree of total leverage is equal to the _____ multiplied by the ______ .
a. degree of operating leverage, variable cost ratio
b. degree of financial leverage, variable cost ratio
c. degree of operating leverage, degree of financial leverage
d. degree of operating leverage, fixed cost ratio
43.
The total variability of EPS associated with a change in sales is an indication of combined leverage best
measured by
a. DOL
c. DOL + DFL
b. DFL
d. DOL x DFL
66.
Assume that Herron, Inc. has a degree of financial leverage of 1.50. If EBIT increases
from $150,000 this year to $165,000 next year, how much will earnings per share (EPS) increase,
assuming no change in capital structure?
a. 6.7%
d. 22.5%
b. 10.0%
e. Cannot be determined from the information
c. 15.0%
given.
68.
A firm markets a product for $30 per unit that has a direct manufacturing cost of $15 per
unit. Its contribution margin is:
a. 50%
d. none of the above
b. 33.33%
c. $15
71.
Assume the following facts about a single product firm:
Selling price per unit
= $25.00
Variable costs per unit
= $21.25
Total monthly fixed costs
= $3,000
What is the firm's annual breakeven volume in sales revenues?
a. $540,000
c. $20,000
b. $240,000
d. $9,600
2
73.
Porter Productions sells video tapes for $15.00 each. Their variable cost per unit is $9.00. In
addition, they incur $180,000 in fixed costs each year. What is the Porter's annual breakeven point in sales
revenue?
a. $ 30,000
d. $450,000
b. $180,000
e. $720,000
c. $300,000
74.
Porter Productions sells video tapes for $15.00 each. Their variable cost per unit is $9.00.
In addition, they incur $180,000 in fixed costs each year.
How many units will Porter have to produce and sell in order to generate an operating income (revenues
minus expenses) of $54,000?
a. 9,000 units
d. 39,000 units
b. 18,000 units
e. 54,000 units
c. 30,000 units
77.
If a company sells 10,000 units at $25 each, has fixed costs of $20,000, and a variable
cost of $20 per unit, what is its degree of operating leverage (DOL)?
a. 1.67
c. 2.0
b. 2.5
d. 1.6
79.
If a company sells 20,000 units at $20 each, has fixed costs of $50,000 and a variable cost
of $10 per unit, what is their degree of operating leverage (DOL)?
a. 1.6
c. 1.33
b. 2.5
d. 1.7
83.
Last year Alpine Growers experienced a 34% increase in earnings per share on 11%
increase in sales. If management knows that Alpine's DOL is 1.5, what is its DFL?
a. 3.09
d. 1.67
b. 2.06
c. 3.55
84.
A firm's EPS increased 27% on a 12% increase in sales. At the same time its EBIT
increased 8% what is the firm's DFL.
a. 1.50
c. 1.34
b. 3.36
d. 0.67
86.
Dittmar Corp. is considering an operational change that will increase its DOL from 2.0 to
3.0. It will be funding this change with debt so that its DFL will increase from 1.2 to 1.5. Analysts believe
that the overall change could increase sales by as much as 10% if it is successful, but could decrease sales
by 6% if it is not successful. What is the range of possible changes in EPS based on this information?
a. decrease of 18% to an increase of 30%
d. decrease of 27% to an increase of 45%
b. decrease of 9% to an increase of 15%
e. decrease of 24% to an increase of 40%
c. decrease of 6% to an increase of 10%
87.
A firm's degree of financial leverage is 2 and the degree of operating leverage is 2.5. An
uncertain economic outlook could mean a 10% reduction in the current level of sales. The firm is
considering an increase of its degree of financial leverage to 3 by issuing additional debt. The degree of
total leverage suggests that the sales volatility could result in a decrease in EPS of as much as:
a. 5.5% if the additional debt is not issued
c. 55% if the additional debt is issued
b. 7.5% if the additional debt is issued
d. 75% if the additional debt is issued
88.
A firm's degree of financial leverage is 1.5 and the degree of operating leverage is 2.0.
What is their degree of total leverage?
a. 9.0
c. 4.5
b. 3.0
d. none of the above
94.
ROE can be converted to EPS by multiplying ROE by ___________.
a. the equity multiplier
c. equity / number of shares
b. ROA
d. 1 / number of shares
3
98.
If a firm has no debt and EBIT increases by 10%, then one can expect _______.
a. EPS to increase by more than 10%
c. EAT to increase by 10%
b. ROE to increase by less than 10%
d. ROCE to be less than ROE
100.
If a product has a contribution margin of 40% and has a price of $5.00 per unit, how many units
must be sold to breakeven assuming a fixed cost of $800,000.00?
a. 1.6 million
c. 0.6 million
b. 0.4 million
d. 0.9 million
4.
Alasco Inc.'s fixed operating costs are $20.8 million and its variable cost ratio is 0.30. The firm
has $10 million in bonds outstanding with a coupon interest rate of 9%. Revenues are $32.2 million.
Compute Alasco's degree of total leverage (DTL).
Key Questions for Chapter 14 (Lab 6)
5 ANS: C
17 D
18 A
19 C
22 C
23 B
26 A
66 C (10% x 1.5 = 15%)
27 D
28 A
30 C
32 D
33 D
39 E
40 E
68 A $15/$30=50%
71 ANS:
B
Annual fixed costs = 3000 x 12=36000
41 B
46 A
47 A
42 C
43 D
36000/(25.00-21.25)=9600
9600 x $25=$240,000
73 D 6/15 = .4; 180000/.4 = 450,000
74 D (180000 + 54000)/(15 - 9) = 39,000
77 A DOL=Q[P-V]/[Q(P-V)-FC]=10000[5]/[10000(5)-20000]=50000/30000=1.67
79 C DOL=Q[P-V]/[Q(P-V)-FC]=20000[10]/[20000(10)-50000]=200000/150000=1.33
83 B DTL = 34/11 = 3.09
87 ANS:
D
DFL = 3.09/1.5 = 2.06
Old DOL = 2 x 2.5 = 5.0
84 ANS:
B
10% x 5.0 = 50%
DTL = 27/12=2.25
New DOL = 3 x 2.5 = 7.5
DOL = 8%/12% = .67
10% x 7.5 = 75%
2.25 = DFL x .67
88 ANS:
B
DFL = 3.36
1.5 x 2 = 3
94 C
86 ANS:
D
98 C
New DOL = 3.0 x 1.5 = 4.5
100 ANS:
B
4.5 x -6% = -27%
$800,000.00
/
(40%*$5.00)
= 0.4 million
4.5 x 10% = 45%
4 This answer takes the approach of calculating both DOL and DFL and multiplying. You could also use
the formula for DTL directly
ANS:
DOL = Q(P-V)/[Q(P-V) - FC ]
DOL = [32.2M-.3(32.2M)]/ [(32.2M-.3(32.2M))-20.8M]=12.95
EBIT = 32.2M-.3(32.2M)-20.8M=1.74M
Interest = 10M(.09)=.9M
DFL = EBIT/[EBIT - I]
DFL = 1.74M/[1.74M-.9M]=2.07
DTL = DFL x DOL = 12.95 x 2.07 = 26
4