St.

PETER’S ENGINEERING COLLEGE

(UGC-AUTONOMOUS)

1.

Degree of total leverage can be applied in measuring change

in _________.

A. EBIT to a percentage change in quantity

B. EPS to a percentage change in EBIT

C. EPS to a percentage change in quantity

D. Quantity to a percentage change in EBIT

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2.

Investors can normally afford to assume larger risks in the

____ phase of the life- cycle.

A. accumulation

B. consolidation

C. spending

D. gifting
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(UGC-AUTONOMOUS)

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3.

The measure of business risk is __________.

A. operating leverage

B. financial leverage

C. total leverage

D. working capital leverage

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4.

__________ is the most important investment decision

because it determines the risk-return characteristics of the
portfolio.

A. Hedging

B. Market timing

C. Performance measurement
 St. PETER’S ENGINEERING COLLEGE
(UGC-AUTONOMOUS)

D. Asset allocation

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5.

The value of EBIT at which EPS is equal to zero is known as

____________.

A. Break-even point

B. Financial break-even point

C. Operating break-even point

D. Overall break-even point

  If sales rise by 3.5% at the firm, then EBIT will rise by 1%.

If EBIT rises by 3.5% at the firm, then EPS will rise by 1%.

If EBIT rises by 1% at the firm, then EPS will rise by 3.5%.

If sales rise by 1% at the firm, then EBIT will rise by 3.5%.

 St. PETER’S ENGINEERING COLLEGE
(UGC-AUTONOMOUS)

A firm has a DFL of 3.5 at X dollars. What does this tell us about the firm?

  If sales rise by 3.5% at the firm, then EBIT will rise by 1%.

If EBIT rises by 3.5% at the firm, then EPS will rise by 1%.

If EBIT rises by 1% at the firm, then EPS will rise by 3.5%.

If sales rise by 1% at the firm, then EBIT will rise by 3.5%.

Higher operating leverage is related to the use of additional

__________.

  fixed costs

variable costs

debt financing

common equity financing

Lower financial leverage is related to the use of additional __________.

 St. PETER’S ENGINEERING COLLEGE
(UGC-AUTONOMOUS)

  fixed costs

variable costs

debt financing

common equity financing

Calculate the break-even (quantity) point given the following

information. The firm has $1,000,000 in fixed costs. The firm produces
only one product and anticipates selling each unit for $25 with variable
costs of $5 per unit.
  200,000

50,000

40,000

There is not sufficient information provided to calculate the sales break-even point.

Calculate the break-even point for sales revenues given the following
information. The firm has $1,000,000 in fixed costs. The firm anticipates
that variable costs will be $1 for every $5 in sales.
 St. PETER’S ENGINEERING COLLEGE
(UGC-AUTONOMOUS)

  $1,250,000

$1,000,000

$250,000

$200,000

Calculate the degree of operating leverage (DOL) at 400,000 units of

quantity sold. The firm has $1,000,000 in fixed costs. The firm
anticipates selling each unit for $25 with variable costs of $5 per unit.

  3.33

1.25

1.14

There is not sufficient information provided to calculate the degree of operating

leverage (DOL).

Which of the following formulas represents a correct calculation of the

degree of operating leverage?

  (Q - QBE)/Q
 St. PETER’S ENGINEERING COLLEGE
(UGC-AUTONOMOUS)

(EBIT) / (EBIT - FC)

[Q(P-V) + FC] / [Q(P-V) ]

[Q(P-V)] / [Q(P-V) - FC]

Calculate the degree of financial leverage (DFL) for a firm when its EBIT
is $2,000,000. The firm has $3,000,000 in debt that costs 10% annually.
The firm also has a 9%, $1,000,000 preferred stock issue outstanding.
The firm pays 40% in taxes.
  0.78

0.80

1.24

1.29

Which of the following formulas represents the correct calculation of the

degree of financial leverage?

  [ NI + T + I ] / [ NI - I - PD/(1-T) ]

EBIT / [ EBIT - I - PD/(1-T) ]

 St. PETER’S ENGINEERING COLLEGE
(UGC-AUTONOMOUS)

EBIT / [ NI - I - PD/(1-T) ]

All of the above are correct methods to calculate the degree of financial leverage
(DFL).

A firm is considering three different financing alternatives -- debt,

preferred stock, and common equity. The firm has created an EBIT-EPS
chart that shows several indifference points. What does each
indifference point show the firm?
  The level of EBIT that generates identical EPS under two alternative financing plans.

The level of sales that generates identical EBIT and EPS figures.

It shows the level of EBIT and EPS at which DFL is identical under two alternative
financing plans.

None of the above.

Which of the following statements is correct?

  The coefficient of variation of EBIT, CVEBIT, is a measure of relative financial risk.

The coefficient of variation of EPS, CVEPS, is a measure of relative total firm risk.

Total firm risk equals business risk times financial risk.

 St. PETER’S ENGINEERING COLLEGE
(UGC-AUTONOMOUS)

A relative measure of relative business risk equals the difference, CV EPS - CVEBIT.

Which of the following statements is not correct regarding the

calculation of the degree of total leverage (DTL)?

  DTLQ units = DOLQ units x DFLEBIT of X dollars

DTLQ units = Q(P-V) / {Q(P-V) - FC - I - [PD/(I-T)]}

DTLS dollars = (EBIT + FC ) / {EBIT - I - [PD/(I-T)]};

DTLS dollars = CVEBIT x DFLE(EBIT)

  1.45

1.86

1.94

2.16
 St. PETER’S ENGINEERING COLLEGE
(UGC-AUTONOMOUS)

The maximum amount of debt (and other fixed-charge financing) that a

firm can adequately service is referred to as the __________.

  debt capacity

debt-service burden

adequacy capacity

fixed-charge burden

The cash required during a specific period to meet interest expenses and
principal payments is referred to as the:

  debt capacity.

debt-service burden.

adequacy capacity.

fixed-charge burden.
 St. PETER’S ENGINEERING COLLEGE
(UGC-AUTONOMOUS)

Which of the following statements is not correct as it relates to

acceptable alternatives to analyzing the appropriate financing mix for a
firm (other than the basic DOL, DFL, and DTL)?

  Comparison of industry capital structure ratios.

Talk with what investment professionals such as analysts, institutions, and

investment bankers believe.

Examine the ratings of the firm's securities by various rating services.

Check the company's Dun & Bradstreet composite credit appraisal.

Which of the following ratings apply to an investment grade quality

security?

  BBB rating by Standard and Poor's.

Ba rating by Moody's.

B rating by Standard and Poor's.

Both the first and second answers are ratings that are considered investment grade.
 St. PETER’S ENGINEERING COLLEGE
(UGC-AUTONOMOUS)

Which of the following costs would be considered a fixed cost?

  Raw materials.

Depreciation.

Bad-debt losses.

Production labor.

Question 16.
Operating leverage measures ____________.

A.  business risk

B.  financial risk

C.  both risks

D.  production risk
Question 17.
An example of a derivative security is ______.

A.  a common share of General Motors

B.  a call option on Mobil stock

C.  a commodity futures contract

D.  B and C
Question 18.
Financial leverage helps one to estimate ____________.

A.  business risk

B.  financial risk

C.  both risks
 St. PETER’S ENGINEERING COLLEGE
(UGC-AUTONOMOUS)

D.  production risk
Question 19.
Traditional approach confines finance function only to _________ funds

A.  raising

B.  mobilizing

C.  utilizing

D.  financing
Question 20.
Operating leverage x Financial leverage = ________

A.  Combined Leverage

B.  Financial Combined Leverage

C.  Operating Combined Leverage

D.  Fixed leverage

Multiple Choice Questions1. Operating leverage helps in analysis of:

(a) Business Risk,(b) Financing Risk,(c) Production Risk,(d) Credit Risk
2. Which of the following is studied with the help of financial leverage?
(a) Marketing Risk,(b) Interest Rate Risk,(c) Foreign Exchange Risk,(d) Financing risk
3. Combined Leverage is obtained from OL and FL by their:
(a) Addition,(b) Subtraction,(c) Multiplication,(d) Any of these
4. High degree of financial leverage means:
(a) High debt proportion,(b) Lower debt proportion,(c) Equal debt and equity,(d) No debt
5. Operating leverage arises because of:
(a) Fixed Cost of Production,(b) Fixed Interest Cost,(c) Variable Cost,(d) None of the above
6. Financial Leverage arises because of:
(a) Fixed cost of production,(b) Variable Cost,(c) Interest Cost,(d) None of the above
7. Operating Leverage is calculated as:
(a) Contribution ÷ EBIT,(b) EBIT÷PBT,(c) EBIT ÷Interest,(d) EBIT ÷Tax
8. Financial Leverage is calculated as:
(a) EBIT÷ Contribution, (b) EBIT÷ PBT,(c) EBIT÷ Sales, (d) EBIT ÷ Variable Cost
9. Which combination is generally good for firms
(a) High OL, High FL (b) Low OL, Low FL, (c) High OL, Low FL,(d) None of these
 St. PETER’S ENGINEERING COLLEGE
(UGC-AUTONOMOUS)

10. Combined leverage can be used to measure the relationship between:

(a) EBIT and EPS,(b) PAT and EPS,(c) Sales and EPS,(d) Sales and EBIT
11. FL is zero if:
(a) EBIT = Interest,(b) EBIT = Zero,(c) EBIT = Fixed Cost,(d) EBIT = Pref. Dividend
12. Business risk can be measured by:
(a) Financial leverage,(b) Operating leverage,(c) Combined leverage,(d) None of the above
13. Financial Leverage measures relationship between
(a) EBIT and PBT,(b) EBIT and EPS,(c) Sales and PBT,(d) Sales and EPS
14. Use of Preference Share Capital in Capital structure
(a) Increases OL,(b) Increases FL,(c) Decreases OL,(d) Decreases FL
15. Relationship between change in sales and change m is measured by:
(a) Financial leverage,(b) Combined leverage(c) Operating leverage,(d) None of the above
16. Operating leverage works when:
(a) Sales Increases, (b) Sales Decreases, (c) Both (a) and (b), (d) None of (a) and (b)
17. Which of the following is correct? (a) CL= OL + FL,(b) -FL,(c) OL= OL × FL,(d) ÷FL
18. If the fixed cost of production is zero, which one of the following is correct?
(a) OL is zero, (b) FL is zero, (c) CL is zero, (d) None of the above
19. If a firm has no debt, which one is correct?(a) OL is one, (b) FL is one, (c) OL is zero,
(d)FL is zero
20. If a company issues new share capital to redeem debentures, then:
(a) OL will increase,(b) FL will increase,(c) OL will decrease,(d) FL will decrease
21. If a firm has a DOL of 2.8, it means:
(a) If sales increase by 2.8%, the EBIT will increase by 1%,(b) If EBIT increase by 2.896, the
EPS will increase by 1 %, (c) If sales rise by 1%, EBIT will rise by 2.8%, (d) None of the
above
22. Higher OL is related to the use of higher:
(a) Debt,(b) Equity,(c) Fixed Cost,(d) Variable Cost
23. Higher FL is related the use of:
(a) Higher Equity,(b) Higher Debt,(c) Lower Debt,(d) None of the above