Objective type questions on leverage analysis

1.    Which of these is true?

1. Financial leverage is the responsiveness of the firm's EBIT to fluctuations in sales.
2. Financial leverage involves the incurrence of fixed operating costs in the firm's income stream.
3. Financial leverage is the responsiveness of the firm's EPS to fluctuations in EBIT.
4. Financial leverage reduces a firm's risk.

2.   Which of the following statements about combined (operating & financial) leverage is true?

1. If a firm employs both operating and financial leverage, any percent change in sales will produce a larger percent change in earnings per share.
2. A firm that is in a capital-intensive industry should use a higher level of financial leverage than a firm that employs low levels of operating leverage.
3. Usage of both operating and financial leverage reduces a firm's risk.
4. High operating leverage and high financial leverage offset one another, meaning that if sales increase by 10%, then EPS will also increase by 10%.

3.   Financing a portion of a firm's assets with securities bearing a fixed rate of return in hopes of increasing the return to stockholders refers to ________.

1. business risk
2. financial leverage
3. operating leverage
4. combined leverage

4.  A high degree of variability in a firm's earnings before interest and taxes refers to ________.

1. business risk
2. financial risk
3. financial leverage
4. operating leverage

5.   Operating leverage refers to ________.

1. financing a portion of the firm's assets with securities bearing a fixed rate of return
2. the additional chance of insolvency borne by the common shareholder
3. the incurrence of fixed operating costs in the firm's income stream
4. a high degree of variable costs of production

6.  Ames Drilling Corp. reported that its sales and EBIT increased by 10%, but its EPS increased by 30%. The much larger change in earnings per share could be the result of ________.

1. high operating leverage
2. high financial leverage
3. a high percentage of credit sale collections from prior years
4. high fixed costs of production

7.  A plant may remain operating when sales are depressed ________.

1. if the selling price per unit exceeds the variable cost per unit
2. to help the local economy
3. in an effort to cover at least some of the variable cost
4. unless variable costs are zero when production is zero

8.   Willows Corporation is experiencing high demand for its products and high growth rates. The company just reported earnings per share of $5 for the most recent year and has many positive NPV projects to fund. One vice president wants to pay a dividend of $5 per share, arguing that this will maximize shareholder value. You argue that a much smaller dividend will maximize value. Your argument may be based on ________.

1. the bird-in-the-hand theory
2. the residual dividend theory
3. the information effect
4. the very high agency costs of the corporation

9. The dividend irrelevance hypothesis is based on all of the following assumptions except:

1. investment decisions will not be altered by the amount of dividend payments
2. investors do not need cash dividends to supplement their current income
3. perfect capital markets
4. borrowing decisions will not be altered by the amount of dividend payments

10.  A corporation with very high growth prospects and many positive NPV projects to fund may want to increase its dividend based on ________.

1. the tax bias against capital gains
2. the residual dividend theory
3. the information effect
4. the very low agency costs of the corporation