NAME: ________________________________ (a) to determine the level of operations necessary to cover

SECTION: _____________________________ all operating costs.

(b) to evaluate the profitability associated with various
LEVERAGE AND CAPITAL STRUCTURE levels of sales.
(c) Both (a) and (b).
Instruction: Write the letter of your answer beside the (d) none of the above.
number for each item.
11. If a firm’s fixed operating costs decrease, the firm’s
1. _________ analysis is a technique used to assess the operating breakeven point will
returns associated with various cost structures and levels (a) decrease. (c) remain unchanged.
of sales. (b) increase. (d) change in undetermined
(a) Time-series (c) Breakeven
(b) Marginal (d) Ratio 12. If a firm’s variable costs per unit increase, the firm’s
operating breakeven point will
2. Earnings before interest and taxes (EBIT) is a (a) decrease. (c) remain unchanged.
descriptive label for (b) increase. (d) change in undetermined
(a) operating profits.
(b) net profits before taxes. 13. If a firm’s sale price per unit decreases, the firm’s
(c) earnings per share. operating breakeven point will
(d) gross profits. (a) decrease. (c) remain unchanged.
(b) increase. (d) change in undetermined
3. _________ costs are a function of time, not sales, and
are typically contractual. 14. If a firm’s fixed financial costs decrease, the firm’s
(a) Fixed (c) Variable operating breakeven point will
(b) Semi-variable (d) Operating (a) decrease. (c) remain unchanged.
(b) increase. (d) change in undetermined
4. _________ costs are a function of volume, not time.
(a) Fixed operating (c) Variable 15. The firm’s operating breakeven point is the point at
(b) Semi-variable (d) Fixed financial which
(a) total operating costs equal total fixed costs.
5. The firm’s _________ is the level of sales necessary to (b) total operating costs are zero.
cover all operating costs, i.e., the point at which EBIT P0. (c) EBIT is less than sales.
(a) cash breakeven point (d) EBIT is zero.
(b) financial breakeven point
(c) operating breakeven point 16. Noncash charges such as depreciation and
(d) total breakeven point amortization _________ the firm’s breakeven point.
(a) do not affect
6. Which of the following is NOT a variable cost? (b) overstate
(a) Materials used. (c) Delivery costs. (c) understate
(b) Rent. (d) Direct labor. (d) decrease

7. _________ costs require the payment of a specified
amount in each accounting period.
(a) Operating (c) Semi-variable
(b) Variable (d) Fixed
8. At the operating breakeven point, _____ equals zero.
(a) sales revenue (c) variable operating costs
(b) fixed operating costs(d) EBIT
9. A firm’s operating breakeven point is sensitive to all of
the following variables EXCEPT
(a) fixed operating costs. (c) interest payment.
(b) sales price per unit. (d) variable cost per unit.
10. Breakeven analysis is used by the firm
17. A firm has fixed operating costs of P525,000, of which
P125,000 is depreciation expense. The firm’s sales price
per unit is P35 and its variable cost per unit is P22.50. The
firm’s cash operating breakeven point in units is
(a) 23,330. (c) 42,000.
(b) 32,000. (d) 52,000.
18. Which one of the following is (are) considered as
limitations of breakeven analysis?
(a) It assumes that the firm faces linear, or nonvarying,
sales revenue and total operating cost functions.
(b) It is difficult to break semivariable costs into fixed and
variable components.
(c) It has a short-term time horizon.
(d) All of the above.

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19. A major assumption of breakeven analysis and one 28._________ results from the use of fixed-cost assets or
which causes severe limitations in its use is that funds to magnify returns to the firm’s owners.
(a) fixed costs really are fixed. (a) Long-term debt (c) Leverage
(b) total revenue is nonlinear. (b) Equity (d) Capital structure
(c) revenues and operating costs are linear.
(d) all costs are really semi-variable. 29.__ leverage is concerned with the relationship between
sales revenues and earnings before interest and taxes.
20. The per peso contribution toward fixed operating (a) Financial (c) Variable
costs and profits provided by each peso of sales is the (b) Operating (d) Total
(a) profit margin. (c)expense ratio.
(b) contribution margin. (d) fixed coverage ratio. 30._________ leverage is concerned with the relationship
between sales revenue and earnings per share.
21. A firm has fixed operating costs of P10,000, the sale (a) Financial (c) Variable
price per unit of its product is P25, and its variable cost (b) Operating (d) Total
per unit is P15. The firm’s operating breakeven point in
units is ___ and its breakeven point in pesos is _____. 31.____ leverage is concerned with the relationship
(a) 250; P 6,250 (c) 667; P16,675 between EBIT and earnings per share.
(b) 400; P10,000 (d) 1,000; P25,000 (a) Financial (c) Variable
(b) Operating (d) Total
22. A firm has fixed operating costs of P150,000, total
sales of P1,500,000, and total variable costs of 32. _________ is the potential use of fixed operating costs
P1,275,000. The firm’s operating breakeven point in to magnify the effects of changes in sales on earnings
pesos is before interest and taxes.
(a) P150,000. (c) P1,000,000. (a) Financial leverage (c) Total leverage
(b) P176,471. (d) P1,425,000. (b) Operating leverage (d) Ratio analysis

23. A firm has fixed operating costs of P253,750, a sales 33. _________ is the potential use of fixed financial
price per unit of P100, and a variable cost per unit of P65. charges to magnify the effects of changes in earnings
The firm’s operating breakeven point in pesos is before interest and taxes on the firm’s earnings per share.
(a) P725,000. (c) P906,250. (a) Financial leverage (c) Total leverage
(b) P700,000. (d) P390,385. (b) Operating leverage (d) Debt service

24. One function of breakeven analysis is to 34. Fixed financial charges include
(a) create profits. (a) common stock dividends and bond interest expense.
(b) describe leverage. (b) common stock dividends and preferred stock
(c) evaluate the profitability of various sales levels. dividends.
(d) determine the amount of financing needed by the firm. (c) bond interest expense and preferred stock dividends.
(d) stock repurchase expense.
25. The preferred approach to breakeven analysis for the
multiproduct firm is the 35. A decrease in fixed financial costs will result in
(a) breakeven point expressed in units. _________ in financial risk.
(b) breakeven point expressed in pesos. (a) an increase (c) no change
(c) cash breakeven point. (b) a decrease (d) an undetermined change
(d) overall breakeven point.
36. The three basic types of leverage are
26. A firm has fixed operating costs of P25,000, a per unit (a) operating, production, and financial.
sales price of P5, and a variable cost per unit of P3. What (b) operating, production, and total.
is its operating breakeven point if it desires net operating (c) production, financial, and total.
income of P10,000, not P0 (zero)? (d) operating, financial, and total.
(a) 12,500 units. (c) 17,500 units.
(b) 15,000 units. (d) 25,000 units. 37. The higher financial leverage causes _________ to
increase more for a given increase in _________.
27. The long-term funds of the firm are called (a) EBIT; sales (c) EPS; EBIT
(a) debt. (c) capital. (b) EPS; sales (d) EBIT; EPS
(b) assets. (d) equity.

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38. _________ is the potential use of fixed costs, both (a) 3.5 (c) 0.5
operating and financial, to magnify the effect of changes (b) 3.0 (d) 1.3
in sales on the firm’s earnings per share.
(a) Debt service (c) Operating leverage 48. Generally, _____ in leverage result in ___ return and
(b) Total leverage (d) Financial leverage ___ risk.
(a) increases; decreased; increased
39. As fixed operating costs increase and all other factors (b) increases; decreased; decreased
are held constant, the degree of operating leverage will (c) increases; increased; increased
(a) an increase (c) no change (d) decreases; increased; decreased
(b) a decrease (d) an undetermined change
49. With the existence of fixed operating costs, an
40. Through the effects of financial leverage, when EBIT increase in sales will result in _________ increase in
increases, earnings per share will EBIT.
(a) an increase (c) no change (a) a proportional (c) a less than proportional
(b) a decrease (d) an undetermined change (b) an equal (d) a more than proportional

41. With the existence of fixed operating costs, a decrease 50. A firm has interest expense of P145,000, preferred
in sales will result in _________ in EBIT. dividends of P25,000, and a tax rate of 40%. The firm’s
(a) a proportional increase financial breakeven point is
(b) an equal increase (a) P 25,000. (c) P186,667.
(c) a less than proportional decrease (b) P170,000. (d) P145,000.
(d) a more than proportional decrease
51. Because the degree of total leverage is multiplicative
42. An increase in fixed operating costs will result in and not additive, when a firm has very high operating
_________ in the degree of operating leverage. leverage it can moderate its total risk by
(a) an increase (c) no change (a) increasing sales.
(b) a decrease (d) an undetermined change (b) using more financial leverage.
(c) increasing EBIT.
43. A firm has fixed operating costs of P650,000, a sales (d) using a lower level of financial leverage.
price per unit of P20, and a variable cost per unit of P13.
At a base sales level of 500,000 units, the firm’s degree 52. The firm’s _________ is the mix of long-term debt
of operating leverage is _________. and equity utilized by the firm, which may significantly
(a) 1.07 (c) 1.18 affect its value by affecting return and risk.
(b) 1.11 (d) 1.23 (a) dividend policy
(b) capital budget
44. A firm has fixed operating costs of P175,000, total (c) capital structure
sales revenue of P3,000,000 and total variable costs of (d) working capital
P2,250,000. The firm’s degree of operating leverage is
(a) 0.77 (c) 0.81 53. The basic sources of capital for a firm include all of
(b) 1.30 (d) 4.29 the following EXCEPT
(a) long-term debt. (c) current liabilities.
45. A firm has EBIT of P375,000, interest expense of (b) preferred stock. (d) common stock.
P75,000, preferred dividends of P6,000 and a tax rate of
40%. The firm’s degree of financial leverage at a base 54. In theory, the firm should maintain financial leverage
EBIT level of P375,000 is _________. consistent with a capital structure that
(a) 0.97 (c) 1.27 (a) meets the industry standard.
(b) 1.29 (d) 1.09 (b) maximizes the earnings per share.
(c) maximizes the owner’s wealth.
46. A decrease in fixed operating costs will result in (d) maximizes dividends.
_________ in the degree of financial leverage.
(a) a decrease (c) no change 55.____ risk is the risk of being unable to cover operating
(b) an increase (d) an undetermined change costs.
(a) Business (c) Leverage
47. At a base sales level of P400,000, a firm has a degree (b) Financial (d) Total
of operating leverage of 2 and a degree of financial
leverage of 1.5. The firm’s degree of total leverage is 56. Business risk is affected by all of the ff. EXCEPT

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(a) revenue stability. (c) operating leverage. (d) equity holders have a higher position in the priority of
(b) cost stability. (d) earnings per share. claims.

57. All of the following affect business risk EXCEPT 65. The key differences between debt and equity capital
(a) operating leverage. (c) cost stability. include all of the following EXCEPT
(b) interest rate stability. (d) revenue stability. (a) voice in management.
(b) maturity.
58. _________ risk is the risk of being unable to cover (c) tax treatment.
financial costs. (d) effect on operating leverage.
(a) Business (c) Total
(b) Financial (d) Leverage 66. The cost of debt financing results from
(a) the increased profitability of bankruptcy caused by
59. After satisfying obligations to creditors, the debt obligations.
government, and preferred stockholders, any remaining (b) the agency costs of the lender’s monitoring and
earnings will most likely be allocated to any of the controlling the firm’s actions.
following EXCEPT (c) the costs associated with managers having more
(a) common shareholders as cash dividends. information about the firm’s prospects than do investors.
(b) common shareholders as stock dividends. (d) All of the above.
(c) retained by the firm for future investment.
(d) a combination of retained earnings & cash dividends. 67. A corporation borrows P1,000,000 at 10 percent
annual rate of interest. The firm has a 40 percent tax rate.
60. The lower risk nature of long-term debt in a firm’s The yearly, after-tax cost of this debt is
capital structure is due to the fact that (a) P 40,000. (c) P100,000.
(a) the equity holders are the true owners of the firm. (b) P 60,000. (d) P166,667.
(b) equity capital has a fixed return.
(c) creditors have a higher position in the priority of 68. A corporation has P5,000,000 of 8 percent preferred
claims. stock outstanding and a 40 percent tax rate. The after-tax
(d) dividend payments are tax-deductible. cost of the preferred stock is
(a) P400,000. (c) P666,667.
61. Which of the following is NOT a reason why debt (b) P240,000. (d) P160,000.
capital is considered to be the least risky source of capital?
(a) It has a high priority claim against assets and earnings. 69. A corporation has P10,000,000 of 10 percent
(b) It has a strong legal position. preferred stock outstanding and a 40 percent tax rate. The
(c) It is a low cost source of capital because interest amount of earnings before interest and taxes (EBIT)
payments are tax deductible. required to pay the preferred dividends is
(d) It does not normally have to be repaid at a specific (a) P1,000,000. (c) P 600,000.
future date. (b) P 400,000. (d) P1,666,667.

62. Probability of bankruptcy is determined by 70. A corporation has P5,000,000 of 10 percent bonds and
(a) financial risk. (c) business risk. P3,000,000 of 12 percent preferred stock outstanding. The
(b) total risk. (d) interest rate risk. firm’s financial breakeven (assuming a 40% tax rate) is
(a) P860,000. (c) P1,100,000.
63. The inexpensive nature of long-term debt in a firm’s (b) P716,000. (d) P1,400,000
capital structure is due to the fact that
(a) the equity holders are the true owners of the firm. 71. The conflict resulting from a manager’s desire to
(b) equity capital has a fixed return. increase the firm’s risk without increasing current
(c) creditors have a higher position in the priority of borrowing costs and lenders’ desire to limit lending is one
claims. effect of the _________ problem.
(d) dividend payments are tax-deductible. (a) agency (c) capital
(b) leverage (d) variable cost
64. The inexpensive nature of long-term debt in a firm’s
capital structure is due to the fact that 72. Operating and financial constraints placed on a
(a) the equity holders are the true owners of the firm. corporation by loan provision are
(b) equity capital has a fixed return. (a) agency costs to the lender.
(c) interest payments are tax-deductible. (b) agency costs to the firm.
(c) interest rate costs to the firm.

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(d) necessary to control the risk of the firm.
73. The risk of the debt capital is less than that of other
long-term contributors of capital because
(a) they have a higher priority of claim against any
earnings or assets available for payment.
(b) they have a far stronger legal pressure against the
company to make payment than do preferred and common
stockholders.
(c) the tax-deductibility of interest payments lowers the
debt cost to the firm substantially.
(d) all of the above.
74. Management has just discovered an excellent
investment for which it needs additional funding. Relative
to the discussion on asymmetric information the firm
should
(a) finance with new common stock if management
believes the firm is undervalued.
(b) finance with debt if management believes the firm is
undervalued.
(c) finance with debt if management believes the firm is
overvalued.
(d) finance with preferred stock if the firm is at value.
75. In order to enhance the wealth of stockholders and to
send positive signals to the market, corporations generally
raise funds using the following order.
(a) Retained earnings, equity, debt.
(b) Retained earnings, debt, equity.
(c) Debt, retained earnings, equity.
(d) Equity, retained earnings, debt.
76.The optimal capital structure is the one that balances
(a) return and risk factors in order to maximize profits.
(b) return and risk factors in order to maximize earnings
per share.
(c) return and risk factors in order to maximize market
value.
(d) return and risk factors in order to maximize dividends.
77. As debt is substituted for equity in the capital structure
and the debt ratio increases, all of the ff. statements about
the component costs of capital are true EXCEPT
(a) the cost of equity continually increases.
(b) the cost of debt continually increases.
(c) the overall cost of capital first declines, reaches a
minimum, and then rises again.
(d) the overall cost of capital continually increases.
78. Poor capital structure decisions can result in _____ the
cost of capital, resulting in _____ acceptable investments.
Effective capital structure decisions can______ the cost
of capital, resulting in ______ acceptable investments.
(a) increasing; fewer; lower; more
(b) decreasing; more; higher; fewer
(c) increasing; more; lower, fewer
(d) decreasing; fewer; higher; more
79. According to the traditional approach to capital
structure, the value of the firm will be maximized when
(a) the financial leverage is maximized.
(b) the cost of debt is minimized.
(c) the weighted average cost of capital is minimized.
(d) the dividend payout is maximized.
80.In the traditional approach to capital structure, as the
amount of debt increases in a firm’s capital structure,
(a) the cost of equity rises faster than the cost of debt.
(b) the cost of debt rises faster than the cost of equity.
(c) debt becomes less risky.
(d) equity cost is unaffected.
81. As debt is substituted for equity in the capital structure
and the debt ratio increases, the behavior of the overall
cost of capital is partially explained by
(a) the tax-deductibility of interest payments.
(b) the increase in the number of common shares
outstanding.
(c) the reduction in risk as perceived by the common
shareholders.
(d) the decrease in the cost of equity.
82. The controversy over the existence of an optimal
capital structure is debated between those _____ who
believe a traditional approach exists and those ______,
who do not believe one exists. In the ______ approach to
capital structure, the optimal capital structure occurs
where the _________ is minimized.
(a) supporters of Modigliani and Miller; traditionalists;
Modigliani and Miller; degree of financial leverage.
(b) traditionalists; supporters of Modigliani and Miller;
traditional; cost of capital
(c) supporters of Modigliani and Miller; traditionalists;
Modigliani and Miller; cost of capital
(d) traditionalists; supporters of Modigliani and Miller;
traditional; degree of financial leverage
83. A firm has an operating profit of P300,000, interest of
P35,000, and a tax rate of 40%. The firm has an after-tax
cost of debt of 5 percent and a cost of equity of 15%. The
firm’s target capital structure is set at a mix of 40 percent
debt and 60% equity. According to the traditional
approach to capital structure, the value of the firm is
(a) P1.4 million. (c) P2.7 million.
(b) P2.0 million. (d) P6.0 million.
84. In the EBIT-EPS approach to capital structure, risk is
represented by
(a) shifts in the cost of equity capital.
(b) shifts in the cost of debt capital.
(c) the slope of the capital structure line.
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(d) shifts in the times-interest-earned ratio.

85. In the EBIT-EPS approach to capital structure, a

constant level of EBIT is assumed
(a) to ease the calculations of owners’ equity.
(b) to isolate the impact on returns of the financing costs
associated with alternative capital structures.
(c) to emphasize the relationship between interest
expenses and taxes.
(d) to concentrate on the effect of revenue and expense on
capital structure decisions.

86. A firm has a current capital structure consisting of

P400,000 of 12% annual interest debt and 50,000 shares
of common stock. The firm’s tax rate is 40 percent on
ordinary income. If the EBIT is expected to be P200,000,
the firm’s earnings per share will be _________.
(a) P2.40 (c) P7.04
(b) P3.04 (d) P1.82

87. The major shortcoming of the EBIT-EPS approach to

capital structure is that
(a) the technique does not promote the maximization of
shareholder wealth.
(b) the technique does not consider the cost of capital.
(c) the technique only considers leverage-related risk.
(d) the technique does not maximize earnings per share.

88. The _____ approach to capital structure proposes that

an optimal capital structure be selected which ______.
(a) M and M; maximizes the weighted average cost of
capital
(b) traditional; minimizes the cost of debt
(c) EBIT-EPS; maximizes the EPS
(d) residual theory; minimizes dividends

89. A firm has a current capital structure consisting of

P400,000 of 12 percent annual interest debt and 50,000
shares of common stock. The firm’s tax rate is 40 percent
on ordinary income. If the EBIT is expected to be
P200,000, two EBIT-EPS coordinates for the firm’s
existing capital structure are
(a) (P36,000, P0) and (P200,000, P3.04).
(b) (P48,000, P0) and (P200,000, P1.82).
(c) (P0, P48,000) and (P200,000, P1.82).
(d) (P152,000, P3.50) and (P150,000, P1.82).

90. The basic shortcoming of the EBIT-EPS approach to

capital structure is
(a) that the optimal capital structure is difficult to
compute.
(b) its disregard for the presence of preferred stock in the
capital structure.
(c) its disregard for the firm’s dividend policy.
(d) that it concentrates on the maximization of EPS rather
than the maximization of owner’s wealth.

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