Multiple Choice: Operating and Financial Leverage
1. The concept of operating leverage involves the use of returns at high levels of operation.
A. Fixed costs
B. Variable costs
C. Marginal costs
D. Semi-variable costs
2. In break-even analysis, the contribution margin is defined as
A. Sales in minus variable costs
B. sales minus fixed costs
C. variable costs minus fixed costs
D. fixed costs minus variable costs
3. If a firm has a break-even point of 20,000 units and the contribution margin on the firm's single product is P3.00 per unit and
fixed costs are P60,000, what will the firm's net income be at ,sales of 30,000 units?
A. P90,000
B. P30,000
C. P15,000
D. P45,000
4. The break-even point can be calculated as
A. Variable costs divided by contribution margin
B. Total costs divided by contribution margin
C. Variable cost times contribution margin
D. Fixed cost divided by contribution margin
5. A highly automated plant would generally have
A. More variable than fixed costs
B. More fixed than variable costs
C. All fixed costs
D. All variable costs
6. Which of the following is concerned with the change in operating profit as a result of a
change in volume?
A. Financial leverage
B. Break-even point
C. Operating leverage
D. Combined leverage
7. The degree of operating leverage is computed as
A. Percent change in operating profit divided by percent change in net income.
B. Percent change in volume divided by percent change in operating profit.
C. Percent change in EPS divided by percent change in operating income.
D. Percent change in operating income divided by percent change in volume.
8. Firm A employs a high degree of operating leverage; Firm B takes a more conservative
approach. Which of the following comparative statements about firms A and B is true?
A. A has a lower break-even point than B, but A's profit grows faster after the break- even.
B. A has a higher break-even point than B, but A's profit grows slower after the break-
even.
C. B has a lower break-even point than A, but A's profit grows faster after break-even.
D. B has a lower break-even point than A, and profit grows the same rate for both companies
after the breakeven point.
9. Firms with a high degree of operating leverage are
A. Easily capable of surviving large changes in sales volume,
B. Usually trading off lower levels of risk for higher profits.
C. Significantly affected by changes in interest rates,
D. Trading off higher fixed costs for lower per-unit variable costs.
rate of 31%, what is
10. If EBIT equals P140,000 and interest equals P21,000, with
the degree of financial leverage?
A. 6.67x
B. 1.18x
C. I.00x
D. 1.12x
11. Financial leverage is concerned with the relation between
A. Changes in volume and changes in EPS.
B. Changes in volume and changes in EBIT.
C. Changes in EBIT and changes in EPS.
D. Changes in EBIT and changes in operating income.
12. A
C. High conservative
degree of financial financing
leverage. plan involves
A. Heavy
D. High degree reliance on leverage.
of combined debt.
B. Heavy reliance on equity.
13. Combined leverage is concerned with the relationship between
A. Changes in EBIT and changes in EPS.
B. Changes in volume and changes in EPS.
C. Changes in volume and changes in EBIT.
D. Changes in EBIT and changes in net income.
14. A firm would be indifferent between financing plans when
A. Debit is equal to equity.
B. Return on assets equals return on equity.
C. The cost of borrowed funds equals the return on equity.
D. The cost of borrowed funds equals the return on assets.
15. If the business cycle were just beginning its upswing, which firm would you anticipate would
be likely to show the best growth in EPS over the next year? Firm A has high combined
leverage and Firm B has low combined leverage.
A. Firm A
B. Firm B
C. Indifferent between the two
D. It depends on how much financial leverage each firm has.
16. Under which of the following conditions could the overuse of financial leverage be
detrimental to the firm?
A. Stable industry
B. Cyclical demand for the firm's products.
C. Upswing of business cycle.
D. Low interest cost compared to return on assets.
17. The degree of operating leverage may be defined as
A. The percent change in operating income divided by the percent change in unit volume.
B. Q (P-VC) divided by Q (P-VC) - FC.
C. S - TVC divided by S -TVC - FC.
D. All of the above.
18. Conservatively leveraged Firm C and highly leveraged Firm H operate at the same level of
earnings before interest and taxes where the return on assets is greater than the cost of debt.
A. Firm C will have a higher return on equity than H.
B. Firm H will have a higher return on equity than C.
C. The return on equity will not be affected by financial leverage.
D. The return on equity will be the same at an equal level of earnings.
19. When a firm employs no debit
A. It has a financial leverage of one.
B. It has a financial leverage of zero.
C. Its operating leverage is equal to its financial leverage.
D. It will not be profitable.
Use the following data to answer questions 20 through 23:
Marcus Company manufactures and sells a single product, Product E. The product sells for P60 per unit
and has a C/M ratio of 40%. The company's monthly fixed expenses are P28,800.
20. The variable cost per unit of Product E is
A. P31.20. C. P36.00.
B. P24.00. D. P28.80.
28,800
21. None of the above = 1,200 units
24
The break-even point for Product E is
A. P48,000. c. 800 units.
B. P72,000. d. 1,000 units.
22. If Marcus Company desires a monthly income equal to 10% of sales, monthly
sales will have to be (ignore taxes)
A. 1,500 units. C. 2,000
units.
B. 760 units. d. 1,600
units.
23. If the selling price were reduced by 5%, variable costs reduced by P1.00, and
fixed costs increased to a total of P38,400, how many units would need to be
sold to earn an income of P21,000 (ignore taxes)?
a. 1,000 units. c. 1,700 units.
b. 2,700 units. d. 2,950 units.
Use the following information to answer questions 24 and 25:
Redwood Furniture Company produces two kinds of chairs: an oak model and a
chestnut wood model. The oak model sells for P60 and the chestnut model sells for
P100. The variable expenses are as follows:
Oak Chesnut
Variable production costs per unit P 30 P 35
Variable selling expenses per unit P6 P5
Expected sales in units next year are: 5,000 oak chairs and 1,000 chestnut chairs. Fixed expenses are
budgeted at P135,000 per year.
24. The yearly break-even point in total sales for the sales mix expected is
A. P270,000 C. P485,000
B. P300,000 D. P500,000
25. The company's overall contribution margin ratio for the sales mix expected is
A. 40% C. 50%
B. 45% D. 60%
26 to 28. Given the following income statement for OR Company for 2014:
Sales (30.000 units) P600,000
Less Operating Expenses:
Variable P390,000
Fixed 140,000 530,000
Net income P70,000
26. The break-even point for 2014 is
A. 26,600 units C. P460,000
B. 17,500 units D. P400,000
27. The Company's degree of operating leverage is
A. 3 C. 4.28
B. 2 D. 8.57
28. The Company's margin of safety (Rounded to the nearest whole percent) is
A. 33% c. 12%
B. 50% d. 67%
Contribution margin Sales
140,000
210,000 = 66.66% or 67%
or
Contribution margin 210,000
Sales = 35%
600,000
29 to 31. Kristin is a distributor of brass picture frames. For 2014, she plans to
purchase for P30 each and sell them for P45 each. Kristin's fixed costs are expected to be P240,000.
Kristin's only other costs will be variable costs of P60 per shipment for preparing the invoice and
delivery documents, organizing the delivery, and following up for collecting accounts receivable. The
P60 cost will be incurred each time Kristin ships an order of picture frames. Regardless of the number
of frames in the order.
29. Suppose Kristin sells 40,000 picture frames in 1,000 shipments in 2014, what is the Kristin's
operating income for 2014?
A. P300,000 C. P240,000
B. P420,000 D. P450,000
30. Suppose Kristin sells 40,000 picture frames in 8000 shipments in 2014, what is the Kristin's
operating income for 2014?
A. P246,000
B. P325,000
C. P211,000
D. P312,000
31. Suppose Kristin anticipates making 500 shipments in 2014. How many picture frames must
Kristin sell to break even in 2014?
A. 18,000
B. 12,000
C. 14,000
D. 16,000
