Ijaz Tahir M.Com & M.

A (Econ)

Chapter 16
Operating and Financial Leverage
Multiple choice questions
Q:1 If I believe in the basic principle of a risk-reward relationship, my conclusion
regarding security ratings and yields between an Aaa bond and a Baa bond would be that:
a. The Aaa bond would have the lower yield.
b. The Aaa bond would have the higher yield.
c. The Baa bond would have lower default risk.
d. Default risks would differ but yields would be equal.
Q:2 A firm's degree of operating leverage (DOL) depends primarily upon its
a. Sales variability.
b. Level of fixed operating costs.
c. Closeness to its operating break-even point.
d. Debt-to-equity ratio.
Q:3 An EBIT-EPS indifference analysis chart is used for
a. Evaluating the effects of business risk on EPS.
b. Examining EPS results for alternative financing plans at varying EBIT
levels.
c. Determining the impact of a change in sales on EBIT.
d. Showing the changes in EPS quality over time.
Q:4 EBIT is usually the same thing as:
a. Funds provided by operations.
b. Earnings before taxes.
c. Net income.
d. Operating profit.
Q:5 In the context of operating leverage break-even analysis, if selling price per unit
rises and all other variables remain constant, the operating break-even point in units will:
a. Fall.
b. Rise.
c. Stay the same.
d. Still be indeterminate until interest and preferred dividends paid are
known.
Q:6 If a firm has a DOL of 5 at Q units, this tell us that:
a. If sales rise by 5%, EBIT will rise by 5%.
b. If sales rise by 1%, EBIT will rise by 1%.
c. If sales rise by 5%, EBIT will fall by 25%.
d. If sales rise by 1%, EBIT will rise by 5%.
Q:7 This statistic can be used as a quantitative measure of relative "financial risk."
a. coefficient of variation of earnings per share (CVEPS)
b. coefficient of variation of operating income (CVEBIT)
c. (CVEPS - CVEBIT)
d. (CVEPS + CVEBIT)
Q:8 A firm's degree of total leverage (DTL) is equal to its degree of operating leverage
its degree of financial leverage (DFL).
a. plus
b. minus
c. divided by
d. multiplied by
Q:9 The further a firm operates above its operating break-even point, the closer its
degree of operating leverage (DOL) measure approaches
a. Minus one.
b. Zero.
c. One.
d. Infinity.

True or false questions

Q:1 If by taking on additional debt the firm's securities rating is likely to be lowered, the
firm should never take on additional debt.

True
False

Ijaz Tahir M.Com & M.A (Econ)

Ijaz Tahir M.Com & M.A (Econ)

Q:2 The operating break-even point is the point at which operating profits equal
revenues minus operating costs.

True
False

Q:3 All other things being the same, if the firm raises funds by selling common stock, it
will increase its degree of financial leverage.

True
False

Q:4 Preferred stock, like debt, could provide financial leverage to a firm.

True
False

Q:5 If EBIT were to remain constant while the firm incurred additional interest expense,
the degree of financial leverage would increase.

True
False

Q:6 Two firms X and Z, have the same EBIT, but X has a $5 million annual debt-service
burden and Z has a $2 million annual debt-service burden. The probability of cash
insolvency is greater with X than with Z.

True
False

Q:7 If a company has no fixed costs, its DOL equals 1.

True
False

Q:8 The EBIT-EPS indifference point between a 100-percent common stock equity
alternative and a mix of common stock equity and preferred stock cannot be calculated.

True
False

Answers Multiple choice questions: 1- a 2-c 3-b 4-d 5-a 6-d 7-c
8-d 9-c
Answers True or false questions: 1-F 2-F 3-F 4 -T 5-T 6-F 7-T
8-F 9-T 10-T

Ijaz Tahir M.Com & M.A (Econ)