Chapt

er12
Lev
erageandCapi
tal
Str
uct
ure

 Mul
ti
pleChoi
ceQuest
ions

1. ____
_____analysisisat
echni
queusedt
oassesst
her
etur
nsassoci
atedwi
thv
ari
ouscost
str
ucturesandl evel
sofsal
es.
(a)Time-seri
es
(b)Marginal
(c)Breakeven
(d)Rati
o
Answer :C
LevelofDiffi
cult
y:1
Learni
ngGoal :1
Topic:BreakevenAnal
ysi
s

2. Earni
ngsbeforeinter
estandt axes(
EBI
T)i
sadescr
ipt
ivel
abel
for
(a)operati
ngprofi
ts.
(b)netprofi
tsbeforetaxes.
(c)earni
ngspershar e.
(d)grossprofi
ts.
Answer :A
LevelofDiff
icul
ty:
1
Learni
ngGoal :1
Topic:EBIT-
EPSAnaly
sis

3. _
___
_____cost sar
eaf
unct
ionoft
ime,
notsal
es,
andar
ety
pical
l
ycont
ract
ual
.
(
a)Fixed
(
b)Semi -v
ariabl
e
(
c)Variable
(
d)Oper at
ing
Answer :A
LevelofDiff
icul
ty:
1
Learni
ngGoal :1
Topic:Operati
ngLever
age

4. _
___
___
__cost
sar
eaf
unct
ionofv
olume,
nott
ime.
481  Gi
t  Pr
man • inci
plesofFi
nance,
Elev
ent
hEdi
ti
on

(
a)Fi
xedoperat
ing
(
b)Semi-
vari
abl
e
(
c)Var
iabl
e
(
d)Fi
xedfi
nanci
al
Answer :C
LevelofDiff
icul
ty:
1
Learni
ngGoal :1
Topic:Operati
ngLever
age

5. Thef i
rm’s_ ___
_ ___
_isthelevelofsal
esnecessar
ytocov
eral
loper
ati
ngcost
s,i
.e.
,the
pointatwhi chEBI T$0.
(a)cashbr eakev enpoint
(b)financi
al breakevenpoint
(c)oper at
ingbr eakevenpoint
(d)totalbreakev enpoint
Answer :C
LevelofDiff
icul
ty:
1
Learni
ngGoal :1
Topic:Operati
ngBreakev
enPoi
nt

6. Whi
chofthefoll
owingi
sNOTav
ari
abl
ecost
?
(
a)Materi
alsused.
(
b)Rent.
(
c)Deli
ver
ycosts.
(
d)Dir
ectlabor
.
Answer :B
LevelofDiff
icul
ty:
1
Learni
ngGoal :1
Topic:Operati
ngLever
age

7. _
___
_____cost sr
equi
ret
hepay
mentofaspeci
fi
edamounti
neachaccount
ingper
iod.
(
a)Oper at
ing
(
b)Variable
(
c)Semi -v
ariabl
e
(
d)Fixed
Answer :D
LevelofDiff
icul
ty:
1
Learni
ngGoal :1
Topic:Operati
ngLever
age

8. Attheoperat
ingbreakevenpoint
,____
___
__equal
szer
o.
(a)sal
esrevenue
(b)fi
xedoperati
ngcosts
(c)vari
abl
eoperatingcosts
(d)earni
ngsbeforeint
erestandtaxes
Answer:D
Level
ofDiff
icul
ty:
1
 Chapt
er12 Lev
erageandCapi
tal
Str
uct
ure  482

Lear
ningGoal
: 1
Topi
c:Operat
ingBr
eakev
enPoi
nt

9. Afi
rm’soper ati
ngbreakevenpoi
nti
ssensi
ti
vet
oal
loft
hef
oll
owi
ngv
ari
abl
esEXCEPT
(
a)fixedoper at
ingcosts.
(
b)salespr i
ceperunit.
(
c)interestpayment.
(
d)var i
ableoperati
ngcostperuni
t.
Answer :C
LevelofDiff
icul
ty:
1
Learni
ngGoal :1
Topic:Operati
ngBreakev
enPoi
nt

10. Breakev
enanal ysi
sisusedbyt hefir
m
(a)todeterminethelevelofoperat
ionsnecessar
ytocoveral
loper
atingcost
s.
(b)toevaluatet
hepr of
itabi
li
tyassociat
edwithvar
iousl
evel
sofsales.
(c)Both(a)and( b)
.
(d)noneoft heabove.
Answer :C
LevelofDiffi
cult
y:2
Learni
ngGoal :1
Topic:BreakevenAnal
ysi
s

11. I
fafi
rm’sfixedoper
ati
ngcost
sdecrease,
thef
ir
m’soper
ati
ngbr
eakev
enpoi
ntwi
l
l
(
a)decrease.
(
b)i
ncrease.
(
c)remainunchanged.
(
d)changei nanundet
ermi
neddi
recti
on.
Answer :A
LevelofDiff
icul
ty:
2
Learni
ngGoal :1
Topic:Operati
ngBreakev
enPoi
nt

12. I
fafi
rm’svari
abl
ecostsperuni
tincrease,
thef
ir
m’soper
ati
ngbr
eakev
enpoi
ntwi
l
l
(
a)decrease.
(
b)i
ncrease.
(
c)remainunchanged.
(
d)changeinanundetermi
neddirecti
on.
Answer :B
LevelofDiff
icul
ty:
2
Learni
ngGoal :1
Topic:Operati
ngBreakev
enPoi
nt

13. I
faf
ir
m’ssal
epr
iceperuni
tdecr
eases,
thef
ir
m’soper
ati
ngbr
eakev
enpoi
ntwi
l
l
483  Gi
t  Pr
man • inci
plesofFi
nance,
Elev
ent
hEdi
ti
on

(
a)decrease.
(
b)i
ncrease.
(
c)remainunchanged.
(
d)changeinanundetermi
neddi
rect
ion.
Answer :B
LevelofDiff
icul
ty:
2
Learni
ngGoal :1
Topic:Operati
ngBreakev
enPoi
nt

14. I
fafi
rm’sfixedfi
nanci
alcost
sdecrease,
thef
ir
m’soper
ati
ngbr
eakev
enpoi
ntwi
l
l
(
a)decrease.
(
b)i
ncrease.
(
c)remainunchanged.
(
d)changei nanundet
ermineddi
recti
on.
Answer :C
LevelofDiff
icul
ty:
2
Learni
ngGoal :1
Topic:Operati
ngBreakev
enPoi
nt

15. Thefir
m’soper atingbr
eakevenpointi
sthepoi
ntatwhi
ch
(a)tot
aloperatingcostsequalt
otalfi
xedcost
s.
(b)tot
aloperatingcostsarezer
o.
(c)EBITisl
esst hansal
es.
(d)EBITiszero.
Answer :D
LevelofDiff
icul
ty:
2
Learni
ngGoal :1
Topic:Operati
ngBreakev
enPoi
nt

16. Noncashchar gessuchasdepr

eci
ati
onandamor
ti
zat
ion_
___
___
__t
hef
ir
m’sbr
eakev
en
point
.
(a)donotaf fect
(b)over
st at
e
(c)understat
e
(d)decrease
Answer :B
LevelofDiff
icul
ty:
4
Learni
ngGoal :1
Topic:Operati
ngBreakev
enPoi
nt

17. Afir
m hasf i
xedoper at
ingcost
sof$525,
000,ofwhich$125,
000isdepreciat
ionexpense.
Thefir
m’ ssalespri
ceperuniti
s$35anditsv
ariabl
ecostperuni
tis$22.50.Thefir
m’s
cashoper at
ingbreakevenpoi
ntinuni
tsi
s
(a)23,330.
(b)32,000.
(c)42,000.
(d)52,000.
 Chapt
er12 Lev
erageandCapi
tal
Str
uct
ure  484

Answer :B
LevelofDiff
icul
ty:
4
Learni
ngGoal :1
Topic:CashOperatingBr
eakev
enPoi
nt(
Equat
ion12.
1,Equat
ion12.
2andEquat
ion12.
3)

18. Whi
choneoft hef ol
lowi
ngis(are)consi deredasli
mi t
ationsofbr eakev
enanalysi
s?
(
a)Itassumest hatthefi
rmfacesl inear
, ornonvar
ying,salesrevenueandtotaloper
ati
ng
costfuncti
ons.
(
b)Iti
sdiffi
cul
tt obreaksemivariablecostsintofi
xedandv ar
iablecomponents.
(
c)Ithasashort -
ter
mt imehorizon.
(
d)Alloftheabov e.
Answer :D
LevelofDiff
icul
ty:
4
Learni
ngGoal :1
Topic:Limi
tati
onsofBr
eakev
enAnal
ysi
s

19. Amaj orassumpti

onofbr eakevenanalysi
sandonewhi
chcausessev
erel
i
mit
ati
onsi
nit
s
useisthat
(a)fi
xedcostsreall
yarefixed.
(b)totalr
evenueisnonl
inear.
(c)revenuesandoperati
ngcost sareli
near.
(d)allcost
sarereall
ysemi -
var
iable.
Answer :C
LevelofDiff
icul
ty:
4
Learni
ngGoal :1
Topic:Limi
tati
onsofBr
eakev
enAnal
ysi
s

20. Theperdollarcontri
buti
ont
owar
dfi
xedoper
ati
ngcost
sandpr
ofi
tspr
ovi
dedbyeachdol
l
ar
ofsal
esist he
(a)prof
itmar gin.
(b)contr
ibuti
onmar gi
n.
(c)expenser ati
o.
(d)fi
xedcov eragerati
o.
Answer :B
LevelofDiff
icul
ty:
4
Learni
ngGoal :1
Topic:Contr
ibut
ionMar
gin

21. Afir
m hasf i
xedoperat
ingcostsof$10,
000,t
hesalepr
iceperuni
tofi
tspr
oducti
s$25,and
i
tsvari
ablecostperuniti
s$15.Thefir
m’soperat
ingbr
eakevenpoi
nti
nuni
tsis__
___
___
_
andit
sbr eakevenpoi
ntindol
larsi
s_____
___
_.
(a)250;$6,250
(b)400;$10,000
(c)667;$16,675
(d)1,
000; $25,
000
Answer:D
LevelofDi
ff
icul
ty:
4
Learni
ngGoal:1
485  Gi
t  Pr
man • inci
plesofFi
nance,
Elev
ent
hEdi
ti
on

Topi
c:Oper
ati
ngBr
eakev
enPoi
nt(
Equat
ion12.
1,Equat
ion12.
2andEquat
ion12.
3)

22. Afir
m hasfi
xedoperat
ingcostsof$150,
000,t
otalsal
esof$1,
500,
000,andt
otal
var
iabl
e
cost
sof$1,275,
000.Thefi
rm’soperat
ingbr
eakevenpointi
ndol
lar
sis
(a)$150,
000.
(b)$176,
471.
(c)$1,
000,
000.
(d)$1,
425,
000.
Answer :C
LevelofDiff
icul
ty:
4
Learni
ngGoal :1
Topic:Doll
arOperati
ngBr
eakev
enPoi
nt(
Equat
ion12.
1,Equat
ion12.
2andEquat
ion12.
3)

23. Afir
m hasfi
xedoperati
ngcostsof$253,
750,asalespr
iceperuni
tof$100,
andav
ari
abl
e
costperuni
tof$65.Thefi
rm’soper
ati
ngbreakevenpoi
ntindoll
arsi
s
(a)$725,
000.
(b)$700,
000.
(c)$906,
250.
(d)$390,
385.
Answer :A
LevelofDiff
icul
ty:
4
Learni
ngGoal :1
Topic:Doll
arOperati
ngBr
eakev
enPoi
nt(
Equat
ion12.
1,Equat
ion12.
2andEquat
ion12.
3)

24. Onef
unct i
onofbreakevenanaly
sisi
sto
(
a)createprofi
ts.
(
b)describelever
age.
(
c)evaluatetheprof
it
abil
it
yofvari
oussal
eslevel
s.
(
d)determinetheamountoff i
nanci
ngneededbythef
ir
m.
Answer :C
LevelofDiffi
cult
y:4
Learni
ngGoal :1
Topic:BreakevenAnal
ysi
s

25. Thepreferr
edappr oacht
obreakevenanalysi
sfort
hemul
ti
productf
ir
mist
he
(a)breakevenpointexpr
essedinuni
ts.
(b)breakevenpointexpr
essedindoll
ars.
(c)cashbreakevenpoint.
(d)overal
lbreakevenpoi
nt.
Answer :B
LevelofDiff
icul
ty:
4
Learni
ngGoal :1
Topic:Doll
arOperati
ngBr
eakev
enPoi
nt

26. Afir
m hasfi
xedoper
ati
ngcostsof$25,
000,aperuni
tsalespri
ceof$5,andavar
iabl
ecost
peruni
tof$3.Whati
sit
soperati
ngbreakev
enpointi
fitdesi
resnetoper
ati
ngi
ncomeof
 Chapt
er12 Lev
erageandCapi
tal
Str
uct
ure  486

$10,
000,not$0(zer
o)?
(a)12,
500unit
s.
(b)15,
000unit
s.
(c)17,
500unit
s.
(d)25,
000unit
s.
Answer :C
LevelofDiff
icul
ty:
4
Learni
ngGoal :1
Topic:Operati
ngBreakev
enPoi
nt(
Equat
ion12.
1,Equat
ion12.
2andEquat
ion12.
3)

27. Thelong-ter
mfundsoft
hef
ir
m ar
ecal
l
ed
(a)debt.
(b)assets.
(c)capit
al.
(d)equit
y.
Answer :C
LevelofDiff
icul
ty:
1
Learni
ngGoal :2
Topic:Capit
alStr
uctur
eBasi
cs

28. ____
_____resultsfr
om t
heuseoff
ixed-
costasset
sorf
undst
omagni
fyr
etur
nst
othef
ir
m’s
owners.
(a)Long-term debt
(b)Equity
(c)Leverage
(d)Capitalst
ructure
Answer :C
LevelofDiff
icul
ty:
1
Learni
ngGoal :2
Topic:Capit
alStr
uctur
eBasi
cs

29. _____
____l ever
ageisconcernedwi
tht
her
elat
ionshi
pbet
weensal
esr
evenuesandear
nings
beforeinterestandtaxes.
(a)Financi al
(b)Oper ating
(c)Variable
(d)Total
Answer :B
LevelofDiff
icul
ty:
1
Learni
ngGoal :2
Topic:Operati
ngLever
age

30. ___
_____
_lev
eragei
sconcer
nedwi
tht
her
elat
ionshi
pbet
weensal
esr
evenueandear
nings
pershar
e.
487  Gi
t  Pr
man • inci
plesofFi
nance,
Elev
ent
hEdi
ti
on

(
a)Fi
nancial
(
b)Operat
ing
(
c)Vari
abl
e
(
d)Tot
al
Answer :D
LevelofDiff
icul
ty:
1
Learni
ngGoal :2
Topic:TotalLev
erage

31. _
____
____leverageisconcer
nedwi
tht
her
elat
ionshi
pbet
weenear
ningsbef
orei
nter
estand
t
axesandear ningspershar
e.
(
a)Financial
(
b)Oper at
ing
(
c)Variabl
e
(
d)Total
Answer :A
LevelofDi f
fi
cul
ty:1
Learni
ngGoal :2
Topic:Financi
alLever
age

32. ______
___isthepot enti
aluseoffixedoperat
ingcost
stomagni
fyt
heef
fect
sofchangesi
n
salesonear ni
ngsbef oreint
erestandtaxes.
(a)Financiall
everage
(b)Operatingleverage
(c)Totallever
age
(d)Ratioanalysi
s
Answer :B
LevelofDiff
icul
ty:
1
Learni
ngGoal :2
Topic:Operati
ngLever
age

33. _
___
_____isthepot enti
aluseoffi
xedfi
nanci
alchargestomagnif
ytheef
fect
sofchanges
i
nearni
ngsbef oreinter
estandtaxesonthefi
rm’searni
ngspershar
e.
(
a)Financiall
everage
(
b)Operatingleverage
(
c)Totallever
age
(
d)Debtser vi
ce
Answer :A
LevelofDi f
fi
cul
ty:1
Learni
ngGoal :2
Topic:Financi
alLever
age

34. Fixedf
inanci
alchar
gesincl
ude
(a)commonst ockdiv
idendsandbondi
nter
estexpense.
 Chapt
er12 Lev
erageandCapi
tal
Str
uct
ure  488

(
b)commonst ockdivi
dendsandpref
err
edstockdi
vi
dends.
(
c)bondinterestexpenseandpref
err
edstockdi
vi
dends.
(
d)stockrepurchaseexpense.
Answer :C
LevelofDi f
fi
cul
ty:1
Learni
ngGoal :2
Topic:Financi
alLever
age

35. Adecr
easeinfi
xedfi
nanci
alcost
swi
l
lresul
tin_
___
___
__i
nfi
nanci
alr
isk.
(
a)anincr
ease
(
b)adecrease
(
c)nochange
(
d)anundeter
minedchange
Answer :B
LevelofDi f
fi
cul
ty:1
Learni
ngGoal :2
Topic:Financi
alLever
age

36. Thethreebasictypesoflever
agear e
(a)operati
ng,producti
on,andfinanci
al.
(b)operati
ng,producti
on,andtotal.
(c)producti
on,fi
nancial
,andtotal.
(d)operati
ng,fi
nancial
,andtotal.
Answer :D
LevelofDiff
icul
ty:
1
Learni
ngGoal :2
Topic:TypesofLever
age

37. Thehigherfinanci
all
ever
agecauses_
___
___
__t
oincr
easemor
eforagi
veni
ncr
easei
n
____
_____
.
(a)EBIT;sales
(b)EPS;sales
(c)EPS;EBIT
(d)EBIT;EPS
Answer :C
LevelofDi f
fi
cul
ty:1
Learni
ngGoal :2
Topic:Financi
alLever
age

38. ____
_____isthepot ent
ialuseoffi
xedcost
s,bot
hoperati
ngandf
inanci
al,
tomagni
fyt
he
eff
ectofchangesi nsal esonthefi
rm’
searni
ngspershare.
(a)Debtser vi
ce
(b)Totallever
age
(c)Operatingleverage
(d)Financiall
everage
Answer:B
Level
ofDiff
icul
ty:
2
489  Gi
t  Pr
man • inci
plesofFi
nance,
Elev
ent
hEdi
ti
on

Lear
ningGoal:
2
Topi
c:Total
Lever
age

39. Asfixedoperat
ingcostsi
ncreaseandall
otherf
act
orsar
ehel
dconst
ant
,thedegr
eeof
operati
nglever
agewill
(a)i
ncrease.
(b)decrease.
(c)remainunchanged.
(d)changeinanundetermineddir
ect
ion.
Answer :A
LevelofDiff
icul
ty:
2
Learni
ngGoal :2
Topic:Operati
ngLever
age

40. Throughtheeffect
soffi
nanci
all
ever
age,whenEBI
Tincr
eases,
ear
ningspershar
ewi
l
l
(a)incr
ease.
(b)decrease.
(c)remainunchanged.
(d)changeinanundetermi
neddir
ecti
on.
Answer :A
LevelofDi f
fi
cul
ty:2
Learni
ngGoal :2
Topic:Financi
alLever
age

41. Withtheexist
enceoffixedoperati
ngcost
s,adecr
easei
nsal
eswi
l
lresul
tin_
___
___
__i
n
EBIT.
(a)aproporti
onali
ncrease
(b)anequal i
ncr
ease
(c)alessthanproport
ionaldecrease
(d)amor ethanproporti
onaldecrease
Answer :D
LevelofDiff
icul
ty:
3
Learni
ngGoal :2
Topic:Operati
ngLever
age

42. Anincreaseinfixedoperat
ingcost
swi
l
lresul
tin_
___
___
__i
nthedegr
eeofoper
ati
ng
l
everage.
(a)adecr ease
(b)anincrease
(c)nochange
(d)anundet er
mi nedchange
Answer :B
LevelofDiff
icul
ty:
3
Learni
ngGoal :2
Topic:Operati
ngLever
age

43. Afir
m hasf
ixedoper
ati
ngcost
sof$650,
000,
asal
espr
iceperuni
tof$20,
andav
ari
abl
e
cost
 Chapt
er12 Lev
erageandCapi
tal
Str
uct
ure  490

perunitof$13.Atabasesal
esl
evel
of500,
000uni
ts,
thef
ir
m’sdegr
eeofoper
ati
ng
l
everage
i
s_ _
__ _
____.
(a)1.07
(b)1.11
(c)1.18
(d)1.23
Answer :D
LevelofDiffi
cul
ty:
3
Learni
ngGoal :2
Topic:DegreeofOper
ati
ngLev
erage(
Equat
ion12.
4andEquat
ion12.
5)

44. Afi
rm hasf i
xedoperat
ingcostsof$175,
000,t
otal
salesrevenueof$3,000,
000andt
otal
var
iablecostsof$2,
250,000.Thef
ir
m’sdegreeofoperat
inglever
ageis_____
___
_.
(
a)0. 77
(
b)1. 30
(
c)0. 81
(
d)4. 29
Answer :B
LevelofDiffi
cul
ty:
3
Learni
ngGoal :2
Topic:DegreeofOper
ati
ngLev
erage(
Equat
ion12.
4andEquat
ion12.
5)

45. Af i
rm hasEBITof$375,
000,i
nter
estexpenseof$75,
000,pr
efer
reddi
vi
dendsof$6,
000
anda
taxrateof40percent
.Thefi
rm’sdegr
eeoff i
nanci
all
ever
ageatabaseEBITlev
elof
$375,000
i
s_ _____
___.
(a)0.97
(b)1.29
(c)1.27
(d)1.09
Answer :B
LevelofDiffi
cul
ty:
3
Learni
ngGoal :2
Topic:DegreeofFinanci
alLev
erage(
Equat
ion12.
6and12.
7)

46. Adecreaseinfi
xedoper
ati
ngcost
swi
l
lresul
tin_
___
___
__i
nthedegr
eeoff
inanci
al
l
ever
age.
(
a)adecr ease
(
b)ani ncr
ease
(
c)nochange
(
d)anundet er
minedchange
Answer :D
LevelofDiffi
cul
ty:
3
Learni
ngGoal :2
Topic:DegreeofFinanci
alLev
erage
491  Gi
t  Pr
man • inci
plesofFi
nance,
Elev
ent
hEdi
ti
on

47. Atabasesaleslevelof$400,
000,afi
rm hasadegreeofoper
ati
nglever
ageof2anda
degreeoff
inanci
allever
ageof1.5.Thefi
rm’sdegr
eeoftotal
lev
erageis__
___
___
_.
(a)3.5
(b)3.0
(c)0.5
(d)1.3
Answer :B
LevelofDiffi
cul
ty:
3
Learni
ngGoal :2
Topic:DegreeofTotal
Lev
erage(
Equat
ion12.
4andEquat
ion12.
5)

48. Gener
ally,__
_____
__inleverager esul
tin_
___
___
__r
etur
nand_
___
___
__r
isk.
(
a)increases;decreased;increased
(
b)increases;decreased;decr eased
(
c)increases;i
ncreased;increased
(
d)decr eases;i
ncreased;decr eased
Answer :C
LevelofDiff
icul
ty:
3
Learni
ngGoal :2
Topic:Lever
age,Retur
nandRi
sk

49. Wit
ht heexist
enceoffi
xedoperat
ingcost
s,ani
ncr
easei
nsal
eswi
l
lresul
tin_
___
___
__
i
ncreaseinEBIT.
(
a)apr oporti
onal
(
b)anequal
(
c)al essthanproport
ional
(
d)amor ethanproport
ional
Answer :D
LevelofDiff
icul
ty:
3
Learni
ngGoal :2
Topic:Operati
ngLever
age

50. Afir
m hasi nt
erestexpenseof$145,
000,pr
efer
reddi
vi
dendsof$25,
000,
andat
axr
ateof
40percent.Thefir
m’sf i
nanci
albr
eakevenpoi
ntis
(a)$25,000.
(b)$170,000.
(c)$186,667.
(d)$145,000.
Answer :C
LevelofDi f
ficul
ty: 3
Learni
ngGoal :2
Topic:FinancialBr eakevenPoi nt
51. Becauset hedegr eeoft otalleverageismult
ipl
icat
iveandnotaddi
ti
ve,
whenaf
ir
m hasv
ery
highoper at
inglev eragei tcanmoder atei
tst
otalri
skby
(a)increasingsal es.
(b)usingmor efinancial leverage.
(c)increasingEBI T.
(d)usingal owerl ev eloff i
nanciallever
age.
 Chapt
er12 Lev
erageandCapi
tal
Str
uct
ure  492

Answer :D
LevelofDiffi
cul
ty:
3
Learni
ngGoal :2
Topic:DegreeofTotal
Lev
erage

52. Thefir
m’s_ _
_______ist
hemi xofl
ong-t
erm debtandequi
tyut
il
izedbyt
hef
ir
m,whi
chmay
signi
fi
cantl
yaffectit
svaluebyaff
ect
ingret
urnandr i
sk.
(a)divi
dendpolicy
(b)capit
albudget
(c)capit
alstr
ucture
(d)workingcapital
Answer :C
LevelofDiff
icul
ty:
1
Learni
ngGoal :3
Topic:Capit
alStr
uctur
eBasi
cs

53. Thebasicsour cesofcapi

tal
foraf
ir
mincl
udeal
loft
hef
oll
owi
ngEXCEPT
(a)l
ong-term debt .
(b)pref
erredst ock.
(c)curr
entli
abi li
ti
es.
(d)commonst ock.
Answer :C
LevelofDiff
icul
ty:
1
Learni
ngGoal :3
Topic:Capit
alStr
uctur
eBasi
cs

54. I
ntheor
y,thefir
m shouldmaintai
nfi
nanci
all
ever
ageconsi
stentwi
thacapi
tal
str
uct
ure
t
hat
(
a)meetst heindustr
ystandar
d.
(
b)max i
mi zestheearni
ngspershare.
(
c)max i
mi zestheowner’swealt
h.
(
d)max i
mi zesdivi
dends.
Answer :C
LevelofDiff
icul
ty:
1
Learni
ngGoal :3
Topic:Capit
alStr
uctur
eBasi
cs

55. _
___
_____ri
skist
her
iskofbei
ngunabl
etocov
eroper
ati
ngcost
s.
(
a)Business
(
b)Financi
al
(
c)Leverage
(
d)Total
Answer:A
Level
ofDiff
icul
ty:
1
493  Gi
t  Pr
man • inci
plesofFi
nance,
Elev
ent
hEdi
ti
on

Lear
ningGoal
:3
Topi
c:Busi
nessRi
sk

56. Busi
nessr iskisaffectedbyal
loft
hef
oll
owi
ngEXCEPT
(a)revenuestabili
ty.
(b)costst abi
l
ity
.
(c)operatinglever
age.
(d)earningspershar e.
Answer :D
LevelofDiff
icul
ty:
1
Learni
ngGoal :3
Topic:Busi
nessRisk

57. Alloft
hef ol
lowingaffectbusi
nessr
iskEXCEPT
(a)operati
ngleverage.
(b)int
erestrat
est abil
i
ty.
(c)coststabil
it
y.
(d)revenuestabil
ity
.
Answer :B
LevelofDiff
icul
ty:
1
Learni
ngGoal :3
Topic:Busi
nessRisk

58. _
___
_____ri
skist
her
iskofbei
ngunabl
etocov
erf
inanci
alcost
s.
(
a)Business
(
b)Financi
al
(
c)Total
(
d)Leverage
Answer :B
LevelofDi f
fi
cul
ty:
1
Learni
ngGoal :3
Topic:Financi
alRi
sk
 Chapt
er12 Lev
erageandCapi
tal
Str
uct
ure  494

59. Aftersatisf
yingobli
gati
onstocreditors,thegover
nment ,andprefer
redstockhol
der
s,any
remainingear ni
ngswill
mostlikel
ybeal locat
edtoanyoft hef
ollowingEXCEPT
(a)commonshar ehol
dersascashdi vidends.
(b)commonshar ehol
dersasstockdi vidends.
(c)retainedbyt hefi
rmforfut
ureinv estment.
(d)acombi nati
onofretai
nedearningsandcashdi vidends.
Answer :B
LevelofDiff
icul
ty:
2
Learni
ngGoal :3
Topic:ConceptofCapi
tal
Str
uct
ure

60. Thelowerri
sknatureofl
ong-term debtinafi
rm’scapi
talst
ruct
urei
sduet
othef
actt
hat
(a)theequi
tyhol
dersarethetrueowner softhefi
rm.
(b)equit
ycapi
talhasafi
xedr eturn.
(c)credi
tor
shaveahigherposi t
ioninthepri
ori
tyofcl
aims.
(d)divi
dendpaymentsaretax-deducti
ble.
Answer :C
LevelofDiff
icul
ty:
2
Learni
ngGoal :3
Topic:ConceptofCapi
tal
Str
uct
ure

61. Whichofthefoll
owi ngisNOTar easonwhydebtcapitali
sconsi
deredtobetheleastr
isky
sourceofcapit
al?
(a)Ithasahighpriori
tyclaim agai
nstassetsandearni
ngs.
(b)Ithasastronglegal posi
ti
on.
(c)Iti
salowcostsour ceofcapitalbecausei
nter
estpaymentsaretaxdeduct
ibl
e.
(d)Itdoesnotnormal l
yhav etober epai
dataspecif
icfutur
edate.
Answer :D
LevelofDiff
icul
ty:
2
Learni
ngGoal :3
Topic:ConceptofCapi
tal
Str
uct
ure

62. Probabili
tyofbankruptcyi
sdet
ermi
nedby
(a)financialri
sk.
(b)total r
isk.
(c)businessr i
sk.
(d)interestrat
erisk.
Answer :B
LevelofDi f
fi
cul
ty:
2
Learni
ngGoal :3
Topic:Financi
alRi
sk
495  Gi
t  Pr
man • inci
plesofFi
nance,
Elev
ent
hEdi
ti
on

63. Theinexpensivenatur
eoflong-term debti
naf i
rm’scapit
alst
ruct
urei
sduet
othef
actt
hat
(a)theequityhol
dersarethetrueowner softhefi
rm.
(b)equit
ycapitalhasafi
xedr eturn.
(c)credi
torshaveahigherposi t
ioninthepri
ori
tyofclai
ms.
(d)divi
dendpay mentsaretax-deducti
ble.
Answer :C
LevelofDiff
icul
ty:
2
Learni
ngGoal :3
Topic:ConceptofCapi
tal
Str
uct
ure

64. Theinexpensiv
enat ureoflong-
ter
m debti
naf i
rm’
scapital
struct
urei
sduet
othef
actt
hat
(a)theequit
yholdersarethet r
ueownersofthefi
rm.
(b)equit
ycapitalhasaf i
xedretur
n.
(c)i
nterestpayment saretax-
deduct
ibl
e.
(d)equit
yholdershav eahigherposi
ti
oninthepri
ori
tyofcl
aims.
Answer :C
LevelofDiff
icul
ty:
2
Learni
ngGoal :3
Topic:ConceptofCapi
tal
Str
uct
ure

65. Thekeydi ff
erencesbetweendebtandequi
tycapi
tal
incl
udeal
loft
hef
oll
owi
ngEXCEPT
(a)voiceinmanagement .
(b)mat uri
ty.
(c)taxtreatment.
(d)eff
ectonoper at
ingl
ever
age.
Answer :D
LevelofDiff
icul
ty:
2
Learni
ngGoal :3
Topic:ConceptofCapi
tal
Str
uct
ure

66. Thecostofdebtf inanci

ngr esult
sfrom
(a)theincreasedprofi
tabil
ityofbankr
uptcycausedbydebtobl
igat
ions.
(b)theagencycost softhel ender’
smoni
t or
ingandcont
rol
li
ngthefir
m’sact
ions.
(c)thecost sassociat
edwi thmanagershavingmoreinf
ormati
onaboutthefi
rm’s
prospectsthandoi nvestors.
(d)Alloftheabov e.
Answer :D
LevelofDiff
icul
ty:
3
Learni
ngGoal :3
Topic:CostofDebtFi
nanci
ng
 Chapt
er12 Lev
erageandCapi
tal
Str
uct
ure  496

67. Acor por

ati
onborrows$1,000,
000at10percentannual
rat
eofi
nter
est
.Thef
ir
m hasa40
percentt
axr at
e.Theyear
ly,af
ter
-t
axcostofthi
sdebtis
(a)$40,000.
(b)$60,000.
(c)$100,000.
(d)$166,667.
Answer :B
LevelofDiff
icul
ty:
3
Learni
ngGoal :3
Topic:CostofDebtFi
nanci
ng

68. Acorporati
onhas$5,000,
000of8per
centpr
eferr
edst
ockout
standi
nganda40per
cent
t
axrate.Theafter
-t
axcostoft
hepref
err
edstockis
(
a)$400, 000.
(
b)$240, 000.
(
c)$666, 667.
(
d)$160, 000.
Answer :A
LevelofDiff
icul
ty:
3
Learni
ngGoal :3
Topic:CostofPrefer
redSt
ockFi
nanci
ng

69. Acor porati

onhas$10,000,
000of10percentprefer
redstockout
standi
nganda40percent
taxrate.Theamountofearningsbef
oreint
erestandtaxes(EBI
T)requi
redt
opaythe
pref
er r
eddividendsi
s
(a)$1,000,000.
(b)$400, 000.
(c)$600, 000.
(d)$1,666,667.
Answer :D
LevelofDiff
icul
ty:
3
Learni
ngGoal :3
Topic:CostofPrefer
redSt
ockFi
nanci
ng

70. Acor por

ati
onhas$5, 000,
000of10percentbondsand$3,
000,
000of12percentpref
err
ed
stockoutstandi
ng.Thefir
m’sfi
nanci
albreakev
en(assumi
nga40percentt
axrate)is
(a)$860,000.
(b)$716,000.
(c)$1,100,
000.
(d)$1,400,
000
Answer :C
LevelofDi f
fi
cul
ty:
3
Learni
ngGoal :3
Topic:Financi
alBr
eakev
enPoi
nt
497  Gi
t  Pr
man • inci
plesofFi
nance,
Elev
ent
hEdi
ti
on

71. Theconf li
ctresul
ti
ngfrom amanager
’sdesi
ret
oincreasethefi
rm’sri
skwit
houti
ncr
easi
ng
curr
entbor rowingcost
sandlender
s’desi
ret
oli
mitlendingisoneeff
ectoft
he___
____
__
problem.
(a)agency
(b)leverage
(c)capital
(d)variablecost
Answer :A
LevelofDiff
icul
ty:
3
Learni
ngGoal :3
Topic:Opti
mal Capit
alSt
ruct
ure

72. Oper
atingandfinanci
alconstr
aint
splacedonacor
por
ati
onbyl
oanpr
ovi
sionar
e
(
a)agencycost stothelender
.
(
b)agencycost stothefir
m.
(
c)interestr
atecoststothefi
rm.
(
d)necessarytocont r
oltheri
skofthefir
m.
Answer :B
LevelofDiff
icul
ty:
3
Learni
ngGoal :3
Topic:AgencyCostsandCapi
tal
Str
uct
ure

73. Theriskoft hedebtcapit

alislessthant hatofotherl
ong-ter
m contr
ibut
orsofcapit
al
because
(a)theyhav eahigherprior
it
yofcl aim agai
nstanyear ni
ngsorassetsavai
lablef
or
pay ment.
(b)theyhav eafarstrongerl
egal pressureagainstt
hecompanyt omakepay mentt
hando
prefer
redandcommonst ockholders.
(c)thetax-deducti
bil
i
tyofinterestpayment slowersthedebtcosttothefi
rm subst
ant
ial
l
y.
(d)alloftheabove.
Answer :D
LevelofDiff
icul
ty:
3
Learni
ngGoal :3
Topic:CostofDebtFi
nanci
ng

74. Managementhasjustdiscoveredanexcellentinv
est mentforwhichitneedsaddi
ti
onal
f
unding.Rel
ati
vet
ot hediscussiononasy mmet ri
cinformationthefi
rm shoul
d
(
a)financewit
hnewcommonst ockifmanagementbel iev
est hefi
rmisunderval
ued.
(
b)financewit
hdebtifmanagementbel i
evesthef ir
mi sunderval
ued.
(
c)financewit
hdebtifmanagementbel i
evesthef ir
mi soverval
ued.
(
d)financewit
hprefer
redstocki fthefi
rmi satvalue.
Answer :B
LevelofDiff
icul
ty:
4
Learni
ngGoal :3
Topic:Asymmet r
icInf
ormat
ionandCapi
tal
Str
uct
ure
 Chapt
er12 Lev
erageandCapi
tal
Str
uct
ure  498

75. Inordertoenhancetheweal thofstockholder

sandtosendposi
ti
vesi
gnal
stot
hemar
ket
,
corporati
onsgeneral
lyraisefundsusingthefoll
owi
ngorder
.
(a)Ret ai
nedearni
ngs,equity,debt
.
(b)Ret ai
nedearni
ngs,debt,equity
.
(c)Debt ,r
etai
nedearni
ngs, equit
y.
(d)Equi t
y,r
etai
nedearnings,debt.
Answer :B
LevelofDiff
icul
ty:
3
Learni
ngGoal :4
Topic:Asymmet r
icInf
ormat
ionandCapi
tal
Str
uct
ure

76. Theopti
malcapit
alstr
uct
urei
stheonet
hatbal
ances
(a)r
etur
nandriskfact
orsi
nordert
omaximi
zeprofit
s.
(b)r
etur
nandriskfact
orsi
nordert
omaximi
zeearningspershar
e.
(c)r
etur
nandriskfact
orsi
nordert
omaximi
zemar ketval
ue.
(d)r
etur
nandriskfact
orsi
nordert
omaximi
zedivi
dends.
Answer :C
LevelofDiff
icul
ty:
3
Learni
ngGoal :4
Topic:Opti
mal Capit
alSt
ruct
ure

77. Asdebtissubsti
tut
edforequityint hecapitalstr
uctur
eandthedebtrat
ioi
ncreases,al
lof
thef
oll
owingstatementsaboutt hecomponentcost sofcapi
tal
aretr
ueEXCEPT
(a)t
hecostofequityconti
nuall
yi ncreases.
(b)t
hecostofdebtcont i
nual
lyincr eases.
(c)t
heov er
all
costofcapital
firstdecl i
nes,reachesaminimum,andthenr
isesagain.
(d)t
heov er
all
costofcapital
cont inuall
yincreases.
Answer :D
LevelofDiff
icul
ty:
3
Learni
ngGoal :4
Topic:Opti
mal Capit
alSt
ruct
ure

78. Poorcapi talstr

ucturedeci si
onscanr esul
tin____
_____thecostofcapit
al,
resul
ti
ngin
____
_ _
___accept ableinvest ments.Ef
fecti
vecapit
alstr
ucturedeci
sionscan_____
___
_the
costofcapi tal,
resulti
ngi n_______
__acceptabl
einvestments.
(a)increasing;fewer ;
lower ;more
(b)decr easing;mor e;hi
gher ;f
ewer
(c)increasing;mor e;lower ,
fewer
(d)decr easing;fewer;higher;more
Answer :A
LevelofDiff
icul
ty:
3
Learni
ngGoal :4
Topic:Opti
mal Capit
alSt
ruct
ure
499  Gi
t  Pr
man • inci
plesofFi
nance,
Elev
ent
hEdi
ti
on

79. Accordi
ngtothet r
adi t
ionalapproacht ocapi
tal
str
uctur
e,t
hev
alueoft
hef
ir
m wi
l
lbe
maximizedwhen
(a)thefi
nanciall
everagei smaximi zed.
(b)thecostofdebti smi ni
mized.
(c)theweightedaveragecostofcapi tal
ismini
mized.
(d)thediv
idendpay outismaxi mized.
Answer :C
LevelofDiff
icul
ty:
3
Learni
ngGoal :4
Topic:Tradi
ti
onalAppr
oacht
oCapi
tal
Str
uct
ure

80. Inthetr
aditi
onalapproachtocapi t
alstr
uct
ure,astheamountofdebti
ncr
easesi
naf
ir
m’s
capit
alstr
uctur
e,
(a)thecostofequityri
sesf ast
erthanthecostofdebt.
(b)thecostofdebtrisesfasterthanthecostofequit
y.
(c)debtbecomesl essrisky.
(d)equit
ycostisunaf f
ected.
Answer :A
LevelofDiff
icul
ty:
3
Learni
ngGoal :4
Topic:Tradi
ti
onalAppr
oacht
oCapi
tal
Str
uct
ure

81. Asdebtissubstit
ut edf orequit
yi nthecapitalstruct
ureandthedebtrat
ioi
ncr
eases,
the
behavi
oroftheov erallcostofcapi tali
spar t
ial
lyexplai
nedby
(a)thetax-
deductibili
tyofinterestpay ments.
(b)thei
ncreaseint henumberofcommonshar esoutst
anding.
(c)thereducti
oninr iskasper ceivedbyt hecommonshar eholder
s.
(d)thedecreaseint hecostofequi ty
.
Answer :A
LevelofDiff
icul
ty:
3
Learni
ngGoal :4
Topic:Tradi
ti
onalAppr
oacht
oCapi
tal
Str
uct
ure

82. Thecont r
oversyov ertheexistenceofanopt i
mal capitalstructureisdebat edbet ween
those_ ______
_ _whobel i
eveat radit
ional appr
oachexi stsandt hose_ _
_ _
___ _
_, whodonot
believ eoneexi sts.Inthe_ __
_ _
__ _
_appr oacht ocapitalstructure,theoptimal capital
struct ureoccur swher ethe_ _______
_i smi ni
mized.
(a)suppor tersofModi gl
ianiandMi l
ler;
tradit
ional
ists;Modi gli
ani andMi l
ler;degreeof
financialleverage.
(b)t raditi
onalists;supportersofModi gl
ianiandMi l
ler;tr
aditional;costofcapi tal
(c)suppor tersofModi gl
ianiandMi l
ler;
tradit
ional
ists;Modi gli
ani andMi l
ler;costofcapi
tal
(d)t raditi
onalists;supportersofModi gl
ianiandMi l
ler;tr
aditional;degreeoff inancial
lev er
age
Answer :B
LevelofDiff
icul
ty:
4
Learni
ngGoal :4
Topic:Tradi
ti
onalApproachv er
susMM ApproachtoCapit
alSt
ruct
ure
83. Afirm hasanoperati
ngpr of
itof$300,
000,
inter
estof$35,
000,
andat axr
ateof40per
cent
.
 Chapt
er12 Lev
erageandCapi
tal
Str
uct
ure  500

Thefir
m hasanaf ter-
taxcostofdebtof5percentandacostofequit
yof15per cent.The
fi
rm’stargetcapi
talst
ructur
eissetatami xof40percentdebtand60percentequit
y .
Accordingtothetradi
ti
onalapproachtocapi
talst
ruct
ure,t
hev al
ueofthefi
rmis
(a)$1.4mi l
li
on.
(b)$2.0mi l
li
on.
(c)$2.7mi l
li
on.
(d)$6.0mi l
li
on.
Answer :C
LevelofDiff
icul
ty:
4
Learni
ngGoal :4
Topic:Tradi
ti
onalAppr
oacht
oCapi
tal
Str
uct
ure

84. I
ntheEBIT-EPSapproachtocapi t
al st
ruct
ure,
riski
srepr
esent
edby
(
a)shif
tsinthecostofequitycapi t
al.
(
b)shif
tsinthecostofdebtcapi t
al.
(
c)theslopeofthecapit
alstructureli
ne.
(
d)shif
tsintheti
mes-int
erest-earnedrati
o.
Answer :C
LevelofDiff
icul
ty:
2
Learni
ngGoal :5
Topic:EBIT-
EPSApproacht
oCapi
tal
Str
uct
ure

85. I
ntheEBI T-
EPSappr oachtocapitalstruct
ure,aconstantl
evelofEBITisassumed
(
a)t oeasethecalculati
onsofowner s’equity
.
(
b)t oisol
atetheimpactonr etur
nsoft hefinanci
ngcostsassociat
edwi t
halter
nati
ve
capit
alstr
uctures.
(
c)t oemphasizether el
ati
onshipbetweeni nter
estexpensesandtaxes.
(
d)t oconcentrat
eont heeffectofr
ev enueandexpenseoncapi talst
ruct
uredecisi
ons.
Answer :B
LevelofDiff
icul
ty:
3
Learni
ngGoal :5
Topic:EBIT-
EPSApproacht
oCapi
tal
Str
uct
ure

86. Afir
m hasacur r
entcapi
talstr
uctur
econsisti
ngof$400,000of12per
centannuali
nter
est
debtand50,000sharesofcommonst ock.Thefi
rm’staxratei
s40percentonordi
nary
i
ncome.IftheEBITisexpectedtobe$200,000,t
hefi
rm’searni
ngspersharewi
llbe
____
_____
.
(a)$2.40
(b)$3.04
(c)$7.04
(d)$1.82
Answer :D
LevelofDiff
icul
ty:
3
Learni
ngGoal :5
Topic:EBIT-
EPSApproacht
oCapi
tal
Str
uct
ure
501  Gi
t  Pr
man • inci
plesofFi
nance,
Elev
ent
hEdi
ti
on

87. Themaj
orshor
tcomi
ngoftheEBIT-EPSapproachtocapi t
alstr
uct
ureist
hat
(a)t
het
echni
quedoesnotpromotethemaximi zat
ionofsharehol
derweal
th.
(b)t
het
echni
quedoesnotconsi
derthecostofcapi t
al.
(c)t
het
echni
queonl
yconsider
sleverage-
rel
atedri
sk.
(d)t
het
echni
quedoesnotmaximizeearni
ngspershar e.
Answer :A
LevelofDiff
icul
ty:
3
Learni
ngGoal :5
Topic:EBIT-
EPSApproacht
oCapi
tal
Str
uct
ure

88. The_ ______

__approacht ocapitalstr
uct
ureproposesthatanopt
imal
capi
tal
str
uct
urebe
selectedwhich_ _
____
_ __
.
(a)M andM; maximizest hewei ght
edaveragecostofcapit
al
(b)tradit
ional;mi
nimizest hecostofdebt
(c)EBI T-
EPS; maximi
zest heEPS
(d)residualtheor
y;minimi zesdivi
dends
Answer :C
LevelofDiff
icul
ty:
3
Learni
ngGoal :5
Topic:EBIT-
EPSApproacht
oCapi
tal
Str
uct
ure

89. Afir
m hasacur rentcapit
al str
uctur
econsi sti
ngof$400,000of12per centannuali
nter
est
debtand50, 000shar esofcommonst ock.Thefi
rm’staxr at
eis40percentonor di
nary
i
ncome.I ftheEBI Tisexpect edtobe$200, 000,t
woEBI T-EPScoordi
natesforthefi
rm’s
exi
stingcapitalstr
uctureare
(a)($36,000,$0)and( $200,000,$3.04).
(b)($48,000,$0)and( $200,000,$1.82).
(c)($0,$48,000)and( $200,000,$1.82).
(d)($152,000,$3.50)and( $150,000,$1.82).
Answer :B
LevelofDiff
icul
ty:
3
Learni
ngGoal :5
Topic:EBIT-
EPSApproacht
oCapi
tal
Str
uct
ure

90. Thebasicshort
comingoft heEBI T-
EPSappr oachtocapi
tal
str
uctur
eis
(a)thatt
heoptimalcapi
talstructur
eisdiff
icultt
ocompute.
(b)i
tsdisr
egardforthepresenceofpr ef
erredstocki
nthecapi
talst
ruct
ure.
(c)i
tsdisr
egardforthefi
rm’ sdiv
idendpoli
cy .
(d)thati
tconcentr
atesont hemaxi mi
zati
onofEPSr athert
hanthemaximizat
ionof
owner’
swealth.
Answer :D
LevelofDiff
icul
ty:
3
Learni
ngGoal :5
Topic:EBIT-
EPSApproacht
oCapi
tal
Str
uct
ure
 Chapt
er12 Lev
erageandCapi
tal
Str
uct
ure  502

91. Afirmi sanal yzingtwopossi bl

ecapitalstr
uctures—30and50per centdebtr at
ios.Thefir
m
hast otal
asset sof$5,000,000andcommonst ockv al
uedat$50pershar e.Thef i
rm hasa
mar ginaltaxrat eof40per centonordinaryincome.Thenumberofcommonshar es
outstandingf oreachoft hecapitalst
ructureswouldbe
(a)30per centdebtr ati
o:30,000sharesand50per centdebtr
ati
o:50,000shar es.
(b)30per centdebtr ati
o:50,000sharesand50per centdebtr
ati
o:70,000shar es.
(c)30per centdebtr ati
o:70,000sharesand50per centdebtr
ati
o:100,000shar es.
(d)30per centdebtr ati
o:70,000sharesand50per centdebtr
ati
o:50,000shar es.
Answer :D
LevelofDiff
icul
ty:
4
Learni
ngGoal :5
Topic:Capit
alStr
uctur
eAnal
ysi
s

92. Afir
mi sanal yzingtwopossi bl
ecapitalst
ructures—30and50per centdebtrati
os.Thefir
m
hastotalasset sof$5,000,000andcommonst ockv aluedat$50pershar e.Thef i
rm hasa
marginaltaxrat eof40per centonordinar
yi ncome.I ftheinter
estrateondebtis7per cent
and9per centf orthe30per centandthe50per centdebtr at
ios,r
espectiv
ely
, t
heamountof
i
nterestont hedebtundereachoft hecapitalstruct
ur esbeingconsideredwouldbe
(a)30per centdebtr ati
o:$105,000and50per centdebtr ati
o:$225,000.
(b)30per centdebtr ati
o:$245,000and50per centdebtr ati
o:$225,000.
(c)30per centdebtr ati
o:$105,000and50per centdebtr ati
o:$250,000.
(d)30per centdebtr ati
o:$135,000and50per centdebtr ati
o:$175,000.
Answer :A
LevelofDiff
icul
ty:
4
Learni
ngGoal :5
Topic:Capit
alStr
uctur
eAnal
ysi
s

93. Financi
all
ever
agemeasur
est
heef
fectoff
ixedf
inanci
ngcost
sont
her
elat
ionshi
pbet
ween
(a)SalesandEBI
T.
(b)SalesandEPS.
(c)EBITandEPS.
(d)noneoftheabove.
Answer :C
LevelofDi f
fi
cul
ty:2
Learni
ngGoal :2
Topic:Financi
alLever
age

94. Operati
nglev
eragemeasur
est
heef
fectoff
ixedf
inanci
ngcost
sont
her
elat
ionshi
p
between
(a)SalesandEBIT.
(b)SalesandEPS.
(c)EBITandEPS.
(d)noneoftheabove.
Answer :D
LevelofDiff
iculty:
3
Learni
ngGoal :2
Topic:OperatingLever
age
95. Operati
nglev eragemeasur
est
heef
fectoff
ixedoper
ati
ngcost
sont
her
elat
ionshi
p
503  Gi
t  Pr
man • inci
plesofFi
nance,
Elev
ent
hEdi
ti
on

between
(a)SalesandEBI
T.
(b)SalesandEPS.
(c)EBITandEPS.
(d)noneoftheabove.
Answer :A
LevelofDiff
icul
ty:
2
Learni
ngGoal :2
Topic:Operati
ngLever
age

96. Financi
all
ever
agemeasur
est
heef
fectoff
ixedoper
ati
ngcost
sont
her
elat
ionshi
p
between
(a)SalesandEBI
T.
(b)SalesandEPS.
(c)EBITandEPS.
(d)noneoftheabove.
Answer :D
LevelofDi f
fi
cul
ty:3
Learni
ngGoal :2
Topic:Financi
alLever
age

97. Total
leveragemeasurest
heef
fectoff
ixedcost
sont
her
elat
ionshi
pbet
ween
(a)SalesandEBIT.
(b)SalesandEPS.
(c)EBITandEPS.
(d)noneoft heabov
e.
Answer :B
LevelofDiff
icul
ty:
2
Learni
ngGoal :2
Topic:TotalLev
erage

98. Tony’sBeachT- Shi

rt
shasfixedannualoper
ati
ngcost
sof$75,000.Tonyretai
lshi
sT-shi
rt
s
for$14.
99eachandt hevar
iablecostperT-
shi
rti
s$4.
99.Basedont hi
sinformati
on,
the
breakevensaleslev
elindol
larsis
(a)$125,495.
(b)$112,425.
(c)$108,995.
(d)noneoft heabove.
Answer :B
LevelofDiff
icul
ty:
3
Learni
ngGoal :1
Topic:Doll
arOperati
ngBr
eakev
enPoi
nt(
Equat
ion12.
1,Equat
ion12.
2andEquat
ion12.
3)
 Chapt
er12 Lev
erageandCapi
tal
Str
uct
ure  504

99. Tony’sBeachT- Shi

rt
shasfixedannual
oper
ati
ngcost
sof$75,000.Tonyretai
lshi
sT-shi
rt
s
for$14.99eachandt hevar
iabl
ecostperT-
shi
rti
s$4.
99.Basedont hi
sinformati
on,
the
breakevensaleslev
elinuni
tsis
(a)7,500.
(b)15,030.
(c)5,003.
(d)noneoft heabove.
Answer :A
LevelofDiff
icul
ty:
2
Learni
ngGoal :1
Topic:Operati
ngBreakev
enPoi
nt(
Equat
ion12.
1,Equat
ion12.
2andEquat
ion12.
3)

100.NicoTr adingCompanymustchoosei t
sopt imal capit
al str
uct ure.Currentl
y,thefi
rm hasa
20per centdebtr ati
oandt hefir
m expect stogener ateadi v i
dendnexty earof$5.44per
share.Di vi
dendsar eexpectedtor emainatt hi
slev eli
ndef i
nitely.Stockholderscurr
ently
requir
ea
12.1per centreturnontheirinv
est ment.Nicoisconsi der i
ngchangi ngi tscapital
structur
eif
i
twoul dbenef i
tsharehol
ders.Thef i
rm estimatest hatifitincreasest hedebtr at
ioto30
percent,itwil
l i
ncreaseit
sexpect eddividendto$5. 82pershar e.Again,divi
dendsar e
expectedt oremai natthi
snewl eveli
ndef i
nit
ely
.Howev er ,
becauseoft headdedr i
sk,the
requir
edr eturndemandedbyst ockholderswi l
lincreaset o12. 6per cent.Basedont his
i
nformat ion,shouldNicomaket hechange?
(a)Yes.
(b)No.
(c)It’
si r
relevant.
(d)Notenoughi nf
ormation.
Answer :A
LevelofDiff
icul
ty:
4
Learni
ngGoal :6
Topic:Opti
mal Capit
alSt
ruct
ureandShar
ehol
derWeal
thMaxi
mizat
ion(
Equat
ion12.
12)
505  Gi
t  Pr
man • inci
plesofFi
nance,
Elev
ent
hEdi
ti
on

 EssayQuest
ions
1. TheMajesti
cBli
ndCo.sell
sitsfi
nishedproductforanaverageof$35perunitwitha
vari
abl
ecostperuni
tof$21.Thecompanyhasf ixedoperati
ngcost
sof$1,050,000.
(a)Cal
culat
ethefi
rm’soperat
ingbreakevenpointinunit
s.
(b)Cal
culat
ethefi
rm’soperat
ingbreakevenpointindoll
ars.
(c)Usi
ng100,000uni
tsasabase, whatisthefir
m’ sdegreeofoper
ati
ngleverage?

Answer
s:
(
a)

(
b)

(
c)

LevelofDif
fi
cul
ty:
3
Learni
ngGoal:2
Topic:Oper
ati
ngBreakev
enAnal
ysi
s(Equat
ion12.
1,Equat
ion12.
2andEquat
ion12.
3)

2. RMM, I
nc.isconsi
der i
ngpur chasingasmal lfi
rminthesamel ineofbusi ness.The
purchasewouldbef inancedbyt hesaleofcommonst ockorabondi ssue.Thef i
nanci
al
managerneedst oev aluatehowt hetwoalter
nati
vefinancingpl answi l
laffecttheear
nings
potenti
alofthefi
rm.Tot alfinancingrequir
edis$4.5mi l
lion.Thef ir
m currentl
yhas
$20,000,
000of12per centbondsand600, 000commonshar esout standi
ng.Thef i
rm can
arr
angef i
nancingoft he$4.5mi l
li
onthrougha14per centbondi ssueorthesal eof
100,000sharesofcommonst ock.Thefir
m hasa40per centtaxr ate.
(a)Whati sthedegreeoff inanciallev
erageforeachplanat$7, 000, 000ofEBI T?
(b)Whati sthefi
nanci albr
eakev enpointforeachplan?
Answer
s:
(
a)

(
b)Fi
nanci
alBr
eakev
enPoi
nt(
BondIssue)$3,
030,
000
Fi
nanci
alBr
eakev
enPoi
nt(
StockI
ssue)$2,
400,
000
LevelofDif
fi
cul
ty:3
Learni
ngGoal:2
Topic:Fi
nanci
alLever
ageandFi
nanci
alBr
eakev
en(
Equat
ion12.
6andEquat
ion12.
7)

3. Li
tt
leLAM,
Inc.hasdeci
dedt
oinv
est$10,
000,
000i
nanewheadquar
ter
sandneedst
o
 Chapt
er12 Lev
erageandCapi
tal
Str
uct
ure  506

determinethebestwayt ofinancetheconst r
ucti
on.Thef i
rm cur
rent
lyhas$50,000,
000of
10per centbondsand4, 000,000commonshar esoutstandi
ng.Thefi
rm canobtaint
he
$10,000,000off i
nancingthrougha10per centbondissueorthesaleof1,000,
000shares
ofcommonst ock.Thefir
m hasa
40per centtaxrate.
(a)Whati st hedegreeoffinanciall
everageforeachplanat$25,000,000ofEBIT?
(b)Whati st hefi
nancialbreakevenpointforeachplan?

Answer
s:
(
a)Bondi
ssuei
nter
est10,
000,
000(
0.10)$1,
000,
000
Cur
renti
nter
est50,
000,
000(
0.10)

(
b)Fi
nanci
alBr
eakev
enPoi
nt(
BondIssue)$6,
000,
000
Fi
nanci
alBr
eakev
enPoi
nt(
StockI
ssue)$5,
000,
000
LevelofDif
fi
cul
ty:3
Learni
ngGoal:2
Topic:Fi
nanci
alLever
ageandFi
nanci
alBr
eakev
en(
Equat
ion12.
6andEquat
ion12.
7)

4. Tri
-St
arProducti
ons,I
nc.i
sev al
uati
ngtwodif
ferentoper
ati
ngst
ruct
ureswhi
char
e
descri
bedbelow.Thefi
rm hasannuali
nter
estexpenseof$250,
commonshares
outst
andi
ngof1,000,andat axrat
eof40percent.

Fixed Pri
ce Var
iabl
eCost
Costs perUni
t perUnit
oper
ati
ngst
ruct
ure $500 $1 $0.
75
1:
oper
ati
ngst
ruct
ure $1,
200 $1 $0.
70
2:

(
a) Foreachoper atingstr
ucture,calculate
(
a1)EBI TandEPSat10, 000,20, 000,and30,000units.
(
a2)t hedegreeofoper ati
nglev erage(DOL)anddegr eeoftotal
lev
erage(DTL)usi
ng
20,000unitsasabasesal esl ev
el.
(
a3)t heoperatingbreakevenpoi ntinunit
s.
(
b)Whi choper ati
ngstructurehasgr eat
eroperati
ngleverageandbusi
nessr i
sk?
(
c)IfTri-StarProducti
ons,Inc.projectssalesof20,000units,
whichoperat
ingstr
uct
urei
s
r
ecommended?

Answer
s:
(
a1)

EBI
T EPS
507  Gi
t  Pr
man • inci
plesofFi
nance,
Elev
ent
hEdi
ti
on

Operati
ng
St
ructure 10,
000 20,
000 30,
000 10,
000 20,
000 30,
000
#1 $2,
000 $4,
500 $7,
000 $1.05 $2.55 $4.05
#2 1,
800 4,800 7,800 0.
93 2.
73 4.
53

(
a2)and(
a3)

Operat
ing Operat
ingBr
eakeven
Str
ucture DOL DTL Poi
ntinUnit
s
#1 1.
11 1.
18 2,
000unit
s
#2 1.
25 1.
32 4,
000unit
s
(b)Oper atingst ructure2hasgreaterfixedcost s,greateroperati
nglever
age,and
greaterbusi nessr i
skthanoperat
ingst ructur e1.
(c)I fsal
esar epr oj
ectedat20,
000uni ts,Tri-
StarPr oducti
on,Inc.shoul
dchoose
operati
ngst ruct
ure2becausei tresultsinahi gherEBI TandEPSf orthefi
rm.
Operatingst ructure2hasahigheroper at
ingbr eakevenpoi nt
,butwithsal
es
esti
mat edat20, 000unitsv
ersusabr eakev enpoi ntof4,000units,t
hefir
m
shouldt akeadv antageoftheaddedl everage.
LevelofDiff
iculty:4
LearningGoal: 2
Topic:Lever
age, Retur n,andRi sk(Equat
ion12.1, Equation12. 2,
Equation12.3,Equati
on
12.4,Equati
on12. 5,Equat i
on12. 8,
Equati
on12. 9,andEquat i
on12. 10)
Tabl
e12.
1
Plan1 Plan2
I
nterestExpense $25,000 $50,000
Preferr
edDivi
dend $3,000 $1, 500
CommonShar es 200,000 100,000
Outstandi
ng
 Chapt
er12 Lev
erageandCapi
tal
Str
uct
ure  508

5. Assumi
nga40per
centt
axr
ate,
whati
sthef
inanci
albr
eakev
enpoi
ntf
oreachpl
an?(
See
Tabl
e12.
1.)
Answer
:Financi
albr
eakev
enpoint
$Int
erestPref
err
edDivi
dends/(
1–t
)
Fi
nanci
ngPlan1:FBP$25,
0003, 000/
(1–0.40)$30,000
Fi
nanci
ngPlan2:FBP$50,
0001, 500/
(1–0.40)$52,500
LevelofDif
fi
cul
ty:
3
Learni
ngGoal:5
Topic:Fi
nanci
alBr
eakev
enPoi
nt

6. Whatist
hedegr
eeoffi
nanci
allev
erageatabasel
evel
EBITof$120,
000f
orbot
hfi
nanci
ng
pl
ans?Thef
ir
m hasa40percenttaxrat
e.(
SeeTabl
e12.1.
)
Answer
:Degr
eeoff
inanci
all
ever
agef
orPl
an1atbasel
evel
ofEBI
T

Degr
eeoff
inanci
all
ever
agef
orPl
an2atbasel
evel
ofEBI
T

LevelofDif
fi
cul
ty:
3
Learni
ngGoal:5
Topic:Degr
eeofFinanci
alLev
erage(
Equat
ion12.
6andEquat
ion12.
7)

7. Whati
stheEPSunderFi
nancingPlan1,
ift
hef
ir
m pr
oject
sEBI
Tof$200,
000andhasat
ax
r
ateof40per
cent
?(SeeTable12.1.)
Answer
:Cal
cul
atet
heEPSwi
tht
hef
ormul
a:

LevelofDif
fi
cul
ty:
3
Learni
ngGoal:5
Topic:Fi
nanci
alBr
eakev
en

8. AtaboutwhatEBI
Tlev
elshoul
dthef
inanci
almanagerbei
ndi
ff
erentt
oei
therpl
an?(
See
Tabl
e12.1.
)
Answer
:

AtEBI
T$75,
000.
LevelofDif
fi
cul
ty:
3
Learni
ngGoal:5
Topic:Fi
nanci
alBr
eakev
en
509  Gi
t  Pr
man • inci
plesofFi
nance,
Elev
ent
hEdi
ti
on

9. Whi
chpl
anhasahi
gherdegr
eeoff
inanci
all
ever
ageandf
inanci
alr
isk?(
SeeTabl
e12.
1.)
Answer
:Fi
nanci
ngPl
an2
LevelofDif
fi
cul
ty:3
Learni
ngGoal:5
Topic:Fi
nanci
alLever
ageandFi
nanci
alRi
sk(
Equat
ion12.
6andEquat
ion12.
7)

10. Fr
ankli
neCoin,
Inc.i
sconsi
der
ingt
wocapital
str
uct
ures.Thekeyi
nfor
mat
ionf
oll
ows.
Assumea
40percentt
axrat
eandexpect
edEBITof$50,
000.

SourceofCapit
al St
ructur
e1 St
ructur
e2
Long-
ter
m debt $500,000@ 8% $350,000@ 7%
Commonst ock 10,
000shares 20,
000shares

(a)Cal
cul
atet
woEBIT-
EPScoordi
natesf
oreachoft
hestr
uctures.
(b)I
ndi
cateov
erwhatEBI
Trange,
ifany,
eachstr
uct
urei
spreferr
ed.
Answer
s:
(
a)

Str
uct
ure1 Str
uct
ure2
EBI
T EPS EBI
T EPS
Coor
dinat
es 40,
000; 0 24,
500; 0
50,
000; 0.
60 50,
000; 0.77
60,
000; 1.
20 60,
000; 1.07
 Chapt
er12 Lev
erageandCapi
tal
Str
uct
ure  510

(
b)Calculat
ionofi ndif
fer
encepoi nt
EPS( Str
ucture1)EPS( Structur
e2)
(EBIT–$40, 000) (
1–0. 40)/10,
000(EBIT–$24, 500)(
1–0.40)
/20,000
I
fEBI Tisexpect edtobel essthan$55,500,str
ucture2wil
lmaxi
mi zeEPS.I
f
EBITisexpect edtobegr eaterthan$55,500,Str
ucture1wil
lmaximizeEPS.
LevelofDi
ffi
cul
ty:
4
Learni
ngGoal:5
Topic:EBI
T-EPSAppr
oacht
oCapi
tal
Str
uct
ure

11. TangshanMi ningCompanymustchoosei tsopt imal capitalst ruct ure.Cur r

ently,thef i
rm
hasa40per centdebtr ati
oandt hefir
m expect stogener ateadi videndnexty earof$4. 89
pershar eanddi vi
dendsar eexpect edt ogr owataconst antr ateof5per centforthe
foreseeablefuture.Stockholderscur r
ent l
yr equir
ea10. 89per centr eturnont heir
i
nv estment.TangshanMi ningisconsi der i
ngchangi ngitscapi tal structureifi
twoul d
benefitshareholders.Thef i
rm estimatest hati fi
ti ncreasest hedebtr ati
oto50per cent,it
willi
ncreasei t
sexpect eddividendt o$5. 24pershar e.Becauseoft headdi t
ionallev erage,
divi
dendgr owt hisexpectedt oincreaset o6per centandt hi
sgr owt hwi llbesustai ned
i
ndef i
nit
ely.Howev er
,becauseoft headdedr i
sk,ther equir
edr et urndemandedby
stockholderswi l
lincr
easet o11. 34per cent.
(a)Whati st hevaluepershar ef orTangshanMi ningundert hecur rentcapitalstruct ure?
(b)Whati st hevaluepershar ef orTangshanMi ningundert hepr oposedcapi talst ructure?
(c)Shoul dTangshanMi ningmaket hecapi talst
ruct urechange?Expl ain.
Answer
s:
(
a)Thecur r
entpri
ceofTangshanMini
ngst ocki
s:
P$4. 89/(0.
1089–0.05)$83.
02
(
b)ThepriceofTangshanMiningst
ockifthecapi
tal
struct
urechangei
smadei
s
expect
edt obe:
P$5. 24/(0.
1134–0.065)$108.
26
(
c)Yes.TangshanMi ni
ngshouldmakethechangebecauseitwil
lmaxi
mize
shareprice.
LevelofDi
ffi
cul
ty:
4
Learni
ngGoal:6
Topic:Opt
imalCapit
alSt
ruct
ureandShar
ehol
derWeal
thMaxi
mizat
ion(
Equat
ion12.
12)