F
D. RISK AND LEVERAGE tell which firm has the greater business risk given the above in
D. To determine which firm has the greater business risk, we n
THEORIES: income (NOI or EBIT) of each firm. Paranaque Corporation wo
Risk if its operating income is at least twice that of Alabang Compan
Business risk
Financial risk 9. Which of the following is incorrect regarding operating leverage?
12. Financial risk refers to the: A. Operating leverage is the degree to which costs are fixed.
A. risk of owning equity securities B. A project's break-even point will be affected by the extent to w
B. risk faced by equity holders when debt is used as sales decline.
C. general business risk of the firm C. If the project has mostly variable costs, it is said to have high o
D. possibility that interest rates will increase D. High operating leverage implies that profits are more sensitive
Market risk 11. The extent to which fixed costs are used in a firm’s operations is ca
Comprehensive A. financial leverage. C. financial leverag
5. A decrease in the debt ratio will least likely affect: B. operating leverage. D. foreign risk expo
A. Financial risk C. Systematic or market risk
B. Business risk D. Total risk Financial Leverage
4. It refers to management strategy of financing assets with borrowed
14. Which of the following situations is likely to have the highest combined business and financial use raise the entity risk thereby impacting on the return on commo
risk impact upon a business? above or below the rate of return on total assets.
A. A new labor-intensive operation is funded with operating cash flows A. Factoring C. Mortgage.
B. A fully automated plant is completed, funded with retained earnings B. Leverage. D. Restructuring
C. A fully automated plant is completed, funded with the issuance of 10-year bonds
D. An automated, but dated plant in the southern region is closed and operations are 1. The use of financial leverage by the firm has a potential impact on w
resumed in a labor-intensive plant in Central Luzon (1) The risk associated with the firm
(2) The return experienced by the shareholder
Operating Leverage (3) The variability of net income
2. Which of the following is a key determinant of operating leverage? (4) The degree of operating leverage
A. Level of debt C. Technology (5) The degree of financial leverage
B. Cost of debt D. Capital structure A. 1, 3, 5 C. 1, 2, 3, 5
B. 2, 3, 4, 5 D. 1, 2, 5
3. The degree of operating leverage for Alabang Company is 3.5, and the degree of operating
leverage for Paranaque Corporation is 7.0. According to this information, which firm is 16. The degree of financial leverage for April Company is 3.0, and the
considered to have greater business risk? for August Corporation is 6.2. According to this information, which
A. Alabang Company. greater overall (total) risk?
B. Paranaque Corporation. A. April Company.
C. The degree of operating leverage is not a measure of business risk, so it is not possible to B. August Corporation.
698
, F
C. The degree of financial leverage is a measure of financial risk, so the only conclusion that 8. Although debt financing is usually the cheapest component of ca
can be made with the information given is that August Corporation has greater financial excess because
risk than April Company -- we cannot tell which firm has greater total risk. A. the interest rates may change.
D. To determine which firm has the greater total risk, we need to know the financial B. the firm's stock price will increase and raise the cost of equity f
breakeven point of each firm. C. the financial risk of the firm may increase and thus drive up
financing.
Weighted average Cost of capital D. none of the above.
6. Which of the following changes would tend to decrease the company cost of capital for a
traditional firm? PROBLEMS:
A. Decrease the proportion of equity financing. Capital structure
B. Increase the market value of the debt. 1
. If the pro forma balance sheet shows that total assets must in
C. Decrease the proportion of debt financing. retaining a debt-equity ratio of .75 then:
D. Decrease the market value of the equity. A. debt must increase by P300,000.
B. equity must increase by the full P400,000.
15. The most commonly held view of capital structure is that the weighted average cost of capital: C. debt must increase by P171,428.
A. falls first with moderate levels of leverage and then increases. D. equity must increase by P100,000.
B. does not change with leverage.
C. increases proportionately with increases in leverage. Optimal capital budget
D. increases with moderate amounts of leverage and then falls. 2
. Absolute Corporation has a capital structure that consists of 65%
company expects to report P100 million in net income this year, an
Target capital structure will be paid out as dividends. How large can the firm's capital bu
10. The mix of debt, preferred stock, and common equity with which the firm plans to raise capital having to include the cost of new common stock in its cost of capita
is called the: A. P100.0 million C. P 50.0 million
A. financial risk C. business risk B. P 67.5 million D. P 32.5 million
B. operating leverage D. target capital structure
Dividend per share
Optimal capital structure 3
. The Salvage Company projects the following for the upcoming yea
13. The mix of debt and equity that minimizes the cost of capital is the: Earnings before interest and taxes
A. optimal operating leverage C. optimal degree of combined leverage Interest expense
B. target financial structure D. optimal capital structure Preferred stock dividends
Common stock dividend payout ratio
7. When establishing their optimal capital structure, firms should strive to: Average number of common shares outstanding
A. minimize the weighted average cost of capital Effective corporate income tax rate
B. minimize the amount of debt financing used The expected dividend per share of common stock is
C. maximize the marginal cost of capital A. P1.70 C. P2.10
D. none of the above B. P1.86 D. P1.00
699
D. RISK AND LEVERAGE tell which firm has the greater business risk given the above in
D. To determine which firm has the greater business risk, we n
THEORIES: income (NOI or EBIT) of each firm. Paranaque Corporation wo
Risk if its operating income is at least twice that of Alabang Compan
Business risk
Financial risk 9. Which of the following is incorrect regarding operating leverage?
12. Financial risk refers to the: A. Operating leverage is the degree to which costs are fixed.
A. risk of owning equity securities B. A project's break-even point will be affected by the extent to w
B. risk faced by equity holders when debt is used as sales decline.
C. general business risk of the firm C. If the project has mostly variable costs, it is said to have high o
D. possibility that interest rates will increase D. High operating leverage implies that profits are more sensitive
Market risk 11. The extent to which fixed costs are used in a firm’s operations is ca
Comprehensive A. financial leverage. C. financial leverag
5. A decrease in the debt ratio will least likely affect: B. operating leverage. D. foreign risk expo
A. Financial risk C. Systematic or market risk
B. Business risk D. Total risk Financial Leverage
4. It refers to management strategy of financing assets with borrowed
14. Which of the following situations is likely to have the highest combined business and financial use raise the entity risk thereby impacting on the return on commo
risk impact upon a business? above or below the rate of return on total assets.
A. A new labor-intensive operation is funded with operating cash flows A. Factoring C. Mortgage.
B. A fully automated plant is completed, funded with retained earnings B. Leverage. D. Restructuring
C. A fully automated plant is completed, funded with the issuance of 10-year bonds
D. An automated, but dated plant in the southern region is closed and operations are 1. The use of financial leverage by the firm has a potential impact on w
resumed in a labor-intensive plant in Central Luzon (1) The risk associated with the firm
(2) The return experienced by the shareholder
Operating Leverage (3) The variability of net income
2. Which of the following is a key determinant of operating leverage? (4) The degree of operating leverage
A. Level of debt C. Technology (5) The degree of financial leverage
B. Cost of debt D. Capital structure A. 1, 3, 5 C. 1, 2, 3, 5
B. 2, 3, 4, 5 D. 1, 2, 5
3. The degree of operating leverage for Alabang Company is 3.5, and the degree of operating
leverage for Paranaque Corporation is 7.0. According to this information, which firm is 16. The degree of financial leverage for April Company is 3.0, and the
considered to have greater business risk? for August Corporation is 6.2. According to this information, which
A. Alabang Company. greater overall (total) risk?
B. Paranaque Corporation. A. April Company.
C. The degree of operating leverage is not a measure of business risk, so it is not possible to B. August Corporation.
698
, F
C. The degree of financial leverage is a measure of financial risk, so the only conclusion that 8. Although debt financing is usually the cheapest component of ca
can be made with the information given is that August Corporation has greater financial excess because
risk than April Company -- we cannot tell which firm has greater total risk. A. the interest rates may change.
D. To determine which firm has the greater total risk, we need to know the financial B. the firm's stock price will increase and raise the cost of equity f
breakeven point of each firm. C. the financial risk of the firm may increase and thus drive up
financing.
Weighted average Cost of capital D. none of the above.
6. Which of the following changes would tend to decrease the company cost of capital for a
traditional firm? PROBLEMS:
A. Decrease the proportion of equity financing. Capital structure
B. Increase the market value of the debt. 1
. If the pro forma balance sheet shows that total assets must in
C. Decrease the proportion of debt financing. retaining a debt-equity ratio of .75 then:
D. Decrease the market value of the equity. A. debt must increase by P300,000.
B. equity must increase by the full P400,000.
15. The most commonly held view of capital structure is that the weighted average cost of capital: C. debt must increase by P171,428.
A. falls first with moderate levels of leverage and then increases. D. equity must increase by P100,000.
B. does not change with leverage.
C. increases proportionately with increases in leverage. Optimal capital budget
D. increases with moderate amounts of leverage and then falls. 2
. Absolute Corporation has a capital structure that consists of 65%
company expects to report P100 million in net income this year, an
Target capital structure will be paid out as dividends. How large can the firm's capital bu
10. The mix of debt, preferred stock, and common equity with which the firm plans to raise capital having to include the cost of new common stock in its cost of capita
is called the: A. P100.0 million C. P 50.0 million
A. financial risk C. business risk B. P 67.5 million D. P 32.5 million
B. operating leverage D. target capital structure
Dividend per share
Optimal capital structure 3
. The Salvage Company projects the following for the upcoming yea
13. The mix of debt and equity that minimizes the cost of capital is the: Earnings before interest and taxes
A. optimal operating leverage C. optimal degree of combined leverage Interest expense
B. target financial structure D. optimal capital structure Preferred stock dividends
Common stock dividend payout ratio
7. When establishing their optimal capital structure, firms should strive to: Average number of common shares outstanding
A. minimize the weighted average cost of capital Effective corporate income tax rate
B. minimize the amount of debt financing used The expected dividend per share of common stock is
C. maximize the marginal cost of capital A. P1.70 C. P2.10
D. none of the above B. P1.86 D. P1.00
699
