Question 1

Which of the following measures the effect on earnings per share (EPS) of a change in operating income (earnings before interest and taxes)?

Accepted Answer

A) Operating leverage 
B) Total leverage 
C) Pooled leverage 
D) Equity leverage 
E) Financial leverage

Question 2

To produce sales of $4,500,000, Azure Inc. uses only 80 percent of its plant capacity. Therefore, Azure can increase its sales to _____ without having to increase its plant and equipment.

Accepted Answer

A) $22,500,000 
B) $3,600,000 
C) $5,625,000 
D) $5,400,000 
E) $8,100,000

Question 3

Which of the following mathematical expressions is used to compute the degree of financial leverage (DFL) at a particular level of earnings before interest and taxes (EBIT)? Assume the firm has no preferred stock.

Accepted Answer

A) DFL = Earnings before interest and taxes ÷ Earnings per share (EPS) 
B) DFL = Gross profit ÷ Earnings before interest and taxes 
C) DFL = Sales ÷ (Earnings before interest and taxes - Interest) 
D) DFL = Earnings before interest and taxes ÷ (Earnings before interest and taxes - Interest) 
E) DFL = (Earnings before interest and taxes - Interest - Taxes) ÷ Number of shares

Question 4

Trident Food Corporation generated the following income statement for the most recent fiscal year:

Sales revenues                                        $150,000
Variable cost of sales                              (120,000)
Gross profit                                                30,000
Fixed operating costs                               (10,000)
Net operating income (EBIT)                   20,000
Interest                                                     (15,000)
Earnings before taxes                                  5,000
Taxes (40%)                                               (2,000)
Net income                                                $3,000

What is Trident Food's degree of total leverage (DTL)?

Accepted Answer

A) 4.0× 
B) 6.0× 
C) 1.5× 
D) 5.0× 
E) 50.0×

Question 5

Financial leverage occurs because of the existence of fixed financial costs, which include _____.

Accepted Answer

A) costs associated with production 
B) preferred dividends 
C) common stock dividends 
D) depreciation expenses 
E) accruals

Question 6

Suppose a firm increases its sales using existing fixed assets. Everything else equal, what effect will the increase in sales have on the firm's degree of operating leverage (DOL)?

Accepted Answer

A) The DOL should increase. 
B) The DOL should decrease. 
C) The DOL should not change, because the amount of fixed asset does not change. 
D) The DOL should increase if fixed operating costs represent a significant proportion of total operating costs; otherwise, the DOL should decrease. 
E) Because the fixed operating costs are not know, the impact on DOL cannot be determined.

Question 7

Which of the following statements about the degree of operating leverage (DOL) is correct?

Accepted Answer

A) The higher the DOL, the closer the firm is to its financial breakeven point. 
B) The higher the DOL, the higher the firm's financial risk. 
C) The lower the DOL, the higher the firm's operating risk. 
D) The higher the DOL, the closer the firm is to its operating breakeven point. 
E) The higher the DOL, the higher the percentage increase in the sales when fixed operating costs change.

Question 8

Accounts that "naturally" fluctuate with changes in routine business operations affect internally generated funds, which are generally referred to as spontaneously generated funds.

Accepted Answer

A) True 
 B)False

Question 9

In which of the following situations will Firm A require greater amounts of external funding (additional funds needed, AFN) to meet its forecasted growth than Firm B? Assume the firms are identical in every other way.

Accepted Answer

A) Firm A operates at full capacity, whereas Firm B does not. 
B) Firm A uses the projected balance sheet method to forecast its pro forms financial statements, whereas Firm B does not. 
C) Firm A generates substantial amounts of spontaneously generated funds, whereas Frim B generates very little. 
D) Firm A has attained substantial economies of scale, whereas Firm B has not. 
E) Firm A operates close to its operating breakeven point, whereas Firm B operates well above its operating breakeven point.

Question 10

Progressive Products makes coolers that sell for $250 each; the fixed production costs are $30,000 when 1,000 or fewer coolers are produced; and variable production costs are $200 per cooler. To the nearest dollar, what is the Progressive's current operating breakeven point?

Accepted Answer

A) $30,000 
B) $16,667 
C) $150,000 
D) $37,500 
E) $200,000

Question 11

The ______ forecast is the most important ingredient of the financial forecasting process. If this forecast is inaccurate, the consequences to the forecasting firm can be serious.

Accepted Answer

A) expense 
B) external financing 
C) sales 
D) accounts receivable 
E) accounts payable

Question 12

Errors in the sales forecast can be offset by similar errors in costs and income forecasts. Thus, as long as the errors are not large, sales forecast accuracy is not critical to the firm.

Accepted Answer

A) True 
 B)False

Question 13

A firm that makes an overly optimistic sales forecast is likely to have a:

Accepted Answer

A) high inventory turnover ratio. 
B) high depreciation expense. 
C) low inventory carrying cost. 
D) high return on equity. 
E) low level of plant and equipment.

Question 14

By definition, a firm's financial breakeven point represents the level of net operating income (NOI) at which its:

Accepted Answer

A) stock value is maximized. 
B) earnings before interest and taxes (EBIT) is equal to zero. 
C) earnings per share (EPS) is equal to zero. 
D) tax liability is equal to zero. 
E) interest expense is equal to zero.

Question 15

______ are assets that must be purchased in large, discrete units.

Accepted Answer

A) Fixed assets 
B) Lumpy assets 
C) Spontaneously generated assets 
D) Excess capacity assets 
E) Long-term assets

Question 16

The degree of financial leverage (DFL) is defined as the percentage change in _____ that results from a given percentage change in earnings before interest and taxes (EBIT).

Accepted Answer

A) sales 
B) net operating income (NOI) 
C) fixed financial costs 
D) net income 
E) earnings per share (EPS)

Question 17

By performing a cost-volume-profit analysis, EZ Rentals discovered that its operating breakeven point, QOpBEP, is at sales equal to $180,000. If EZ wants to decrease its operating breakeven point, which of the following actions should be taken? Assume everything else is equal.

Accepted Answer

A) Increase fixed operating costs. 
B) Decrease sales. 
C) Increase the variable operating cost ratio. 
D) Decrease fixed financial costs. 
E) Increase the product's contribution margin.

Question 18

The additional funds needed (AFN) to achieve a particular growth in sales will be negative if:

Accepted Answer

A) assets that are required to support the growth can be acquired only in large, discrete amounts. 
B) the amount of plant and equipment that is required to manufacture additional products is substantial. 
C) the amount of internal financing the firm expects to generate is greater than the amount of external funds that must be raised to support the growth. 
D) the firm must issue new long-term bonds to support the increase in sales. 
E) the amount of internally generated funds is more than sufficient to support the forecasted increase in sales.

Question 19

Which of the following mathematical equations is used to calculate the degree of operating leverage (DOL)? (Δ = change)

Accepted Answer

A) DOL = % Δ in net operating income (NOI)/% Δ in sales 
B) DOL = % Δ in sales/% Δ in earnings before taxes (EBT) 
C) DOL = % Δ in earnings before interest and taxes (EBIT)/% Δ in earnings per share (EPS) 
D) DOL = % Δ in sales/% Δ in earnings per share (EPS) 
E) DOL = % Δ in earnings per share (EPS)/% Δ in earnings before taxes (EBT)

Question 20

In the financial control phase of the financial planning process, a firm is primarily concerned with:

Accepted Answer

A) the amount of funds it generates internally. 
B) determining the investments it should purchase with free cash flows. 
C) determining its financial breakeven point. 
D) the degree of financial leverage that is acceptable. 
E) implementing financial plans and dealing with the feedback and the adjustments needed to meet its goals.

Exam 16: Financial Planning and Control

Which of the following measures the effect on earnings per share (EPS) of a change in operating income (earnings before interest and taxes) ?