Financial management course

1. Tutorial 1
True Or False
1) Operating leverage is measured as the responsiveness of the firm's earnings before
interest and taxes relative to fluctuations in sales.
2) The more fixed-charge securities (such as bonds and preferred stock) the firm
employs in its financial structure, the greater its financial leverage.
3) The presence of debt and/or preferred stock in a firm's financial structure means
the firm is using financial leverage.
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T T T
1) Which of the following ratios gives a perspective on risk in the capital structure?
a. Book value per share b. Dividend yield c. Dividend payout d. Degree of financial leverage
e. Price/earnings ratio
2) Which of the following transactions will lower a company's financial leverage?
A) A mortgage loan is obtained and the proceeds are used to pay off existing short-term debt.
B) Preferred stock is sold and the proceeds are used to pay off existing short-term debt.
C) Common stock is sold and the proceeds are used to pay off existing short-term debt.
D) Short-term debt is obtained to get the company through a period of negative net income
and cash flow.
3) Operating leverage refers to
A) financing a portion of the firm's assets with securities bearing a fixed rate of return.
B) the additional chance of insolvency borne by the common shareholder.
C) the incurrence of fixed operating costs in the firm's income stream.
D) a high degree of variable costs of production.

2. 4) If a firm has no operating leverage and no financial leverage, then a 10% increase in sales
will have what effect on EPS?
A) EPS will remain the same.
B) EPS will increase by 10%.
C) EPS will decrease by 10%.
D) EPS will increase by less than 10%.
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D c C b
(1) A firm has earnings before interest and tax of $1,000,000, interest of
$200,000,outstanding cs 1000 and net income of $400,000 in Year 1.
Required: a. If earnings before interest and tax increase by 10% in Year 2, what will be the
new level of earnings, assuming the same tax rate as in Year 1? Calculate the degree of
financial leverage.
2) The following information pertains to the Classic Burger Restaurant chain:
If sales increase and the variable cost by 10% calculate the degree of operating leverage ?
Sales $600,000
Variable costs 300,000
Total contribution
margin 300,000
Fixed costs 100,000
EBIT 200,000
Interest expense 50,000
Earnings before taxes 150,000
Taxes (30%) 45,000
Net income $105,000