Chapter 13 & 14 Exam

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Finance Exam Chapters 13 & 14 Alissa Mack CH 13&14 Assignment : 71/71 1. Choose the optimal capital structure a. 30% Debt, WACC 10% b. 40% Debt, WACC 11% c. 35% Debt, WACC 9% d. 50% Debt, WACC 12% 2. When a company adds more debt to its capital structure why does this increase the risk of the firm? a. Because operating leverage involves the use of assets with fixed expenses which will not go down if sales decrease b. Because operating leverage involves the use of debt with fixed interest payments which will not go down if sales decrease c. Because financial leverage involves the use of assets with fixed expenses which will not go down if sales decrease d. Because financial leverage involves the use of debt with fixed interest payments which will not go down if sales decrease 3. What is leverage? a. The use of assets with fixed expenses to boost potential returns b. The use of debt with fixed expenses to boost potential returns c. The use of preferred stock with fixed dividends to boost potential returns d. All the above are forms of leverage 4. When is operating leverage good for a company? a. When sales are increasing b. When sales don’t change c. When sales are decreasing d. Operating leverage is never good for a company 5. Which of the following is consider a fixed expense? a. Hourly wages b. Interest on a bond c. Cost of goods sold d. Taxes 6. Why does the use of operating leverage increase the potential return to stockholders? a. As sales go up, assets with fixed expenses do not change, and this helps profitability b. As sales go down, assets with variable expenses go down and this helps profitability c. As sales go up, assets with fixed expenses go down and this helps profitability d. As sales go up, debt interest payments are fixed and this helps profitability

7. Which of the following is true about leverage? a. More leverage never increases the risk of the firm b. More leverage always increases the risk of the firm c. More leverage always increases the profit of a firm d. More leverage never increases the profit of a firm 8. As more debt is added to the firm’s capital structure, which of the following is generally true? a. Borrowing rates will go down b. Borrowing rates are unchanged c. Borrowing rates will go up d. None of the above 9. This type of cost varies in relation to changes in sales a. Variable revenue b. Fixed revenue c. Fixed expense d. Variable expense 10. What is capital structure? a. The percentage of equity, preferred stock and debt used to finance a firm b. The discount rate used to calculate NPV c. The amount of return it takes to meet the firms required rate of return d. None of the above 11. Which type of company generally has the most business risk? a. Firms that have very stable sales and profits b. Firms that experience large swings in sales and profits c. Firms that have very stable selling prices d. Firms that have very little employee or customer turnover 12. According to the pecking order theory, which form of financing is generally used first because it is the least expensive? a. Common Stock b. Preferred Stock c. Debt d. Retained Earnings

13. What is the optimal capital structure based on the following information? Answer: _______7.30%________________ (Please fill in chart and pick the best) % Debt AT Cost Debt % Equity Cost Equity Weighted Average Cost of Capital 50% 5% 50% 12% 8.50% 40% 4.9% 60% 9% 7.36% 30% 4.5% 70% 8.5% .085 7.30% 20% 4.4% 80% 8.3% .083 7.52% 14. Fill in the yellow shaded boxes in the table below: Debt/Total Assets 0% 30% 70% Total Assets 2,000,000 2,000,000 2,000,000 Debt 0 600,000 1,400,000 Equity 2,000,000 1,400,000 600,000 Total Liabilities and Equity 2,000,000 2,000,000 2,000,000 Operating Income (EBIT)= (Sales – Operating Expenses) 300,000 300,000 300,000 Interest Rate on Debt 12% 14% 16% Interest 0 84,000 224,000 Earnings Before Tax (EBT) 300,000 216,000 76,000 Income tax (34%) 102,000 73,440 25,840 Net Income 198,000 142,560 50,160 Return on Equity (ROE) 9.90% 10.18% 8.36% 15. Refer to the table above, if operating income dropped to 0, what level of debt would suffer the greatest decrease in return on equity? a. 0% b. 30% c. 70%

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16. Fill in the yellow shaded boxes in the table below: Var/Fixed 12% increase % change Sales 4,000,000 4,480,000 12.00% Variable Cost (60%) V 2,400,000 2,688,000 12.00% Fixed Cost F 1,000,000 1,000,000 0% Operating Income (EBIT) 600,000 792,000 32.00% Interest F 250,000 250,000 0% EBT 350,000 542,000 54.86% Taxes (34%) V 119,000 184,280 54.86% Earnings After Taxes 231,000 357,720 54.86% Preferred Dividends F 150,000 150,000 0% Earnings available to common stockholders 81,000 207,720 156.44% Earnings per share assuming 50,000 shares 1.62 4.15 156.17% Calculate each item below using the information from the table above: a. Degree of Operating Leverage = % Change in EBIT % Change in Sales 2.67X b. Degree of Financial Leverage = % Change in EPS % Change in EBIT 4.88X c. Degree of Combined Leverage = % Change in EPS % Change in Sales 13.01X Operating Leverage Financial Leverage