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Corporate Finance - Corporate Finance Section 2

Avatto > > CFA Level 1 > > PRACTICE QUESTIONS > > Corporate Finance > > Corporate Finance Section 2

51. Fred has the following information available.

Operating
income		$500,000
Net income $275,000

  • Option : C
  • Explanation : First, compute the degree of financial leverage: 500,000 / 275,000 = 1.818. Next, compute the degree of operating leverage: DTL = Degree of financial leverage * Degree of operational leverage. 3.63 = 1.818 * Degree of operational leverage. DOL = 2.
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52. Alpha and Beta both operate in the automobile sector with the same degree of operating leverage. Alpha has a capital structure of 40% debt and 60% equity, while Beta is financed completely by equity. Which of the following statements is most accurate? Compared to Beta, Alpha has:

  • Option : A
  • Explanation : Alpha’s degree of operating leverage is the same as Beta’s, whereas Alpha’s degree of total leverage and degree of financial leverage are higher.
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53. All else equal, company A has greater financial leverage compared to its counterpart company B. Which of the following statements is least accurate?

  • Option : B
  • Explanation : Financial leverage reduces net income by the interest cost, but increases return on equity because net income is generated with less equity.
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54. A company manufactures items with a selling price of $125 at a variable cost of $62.5 per unit. The operating fixed costs incurred by the company are $250,000, while the fixed interest charges incurred are $65,000. The company is liable to pay taxes at a rate of 35%. The quantity of items that the company should manufacture and sell to break-even is closest to:

  • Option : A
  • Explanation : Breakeven quantity = (Fixed operating costs + fixed financial costs) / (Price per unit – variable cost per unit) = (F + C) / (P - V) = (250,000 + 65,000) / (125 – 62.5) = 5,040.
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55. Soomros now sells 1 million units at Rs.3,972 per unit. Fixed operating costs are Rs.1,960 million and variable operating costs are Rs.1,250 per unit. If the company pays Rs.376 million in interest, the levels of sales at the operating breakeven and the level of sales at the breakeven points are, respectively:

  • Option : A
  • Explanation : Operating breakeven units = F / (P - V) = (Rs.1,960 million) / (Rs.3,972 - Rs.1,250)
    = 720,058.7803 units Operating breakeven sales
    = Rs.3,972 * 720,058.7803 units = Rs.2,860,073,475
    or
    Operating breakeven sales = (Rs.1,960 million) / [1 - (Rs.1,250 /Rs.3,972)] = Rs.2,860,073,475
    Total breakeven = (Rs.1,960 million + Rs.376 million) / (Rs.3,972 - Rs.1,250) = (Rs.2,336 million ) / 2,722 = 858,192.5055
    Breakeven sales = Rs.3,972 * 858,192.5055 units = Rs.3,408,740,632
    or
    Breakeven sales = (Rs.2,336 million) / [1- (Rs.1,250 / Rs.3,972)]
    = Rs.3,408,740,632.
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Corporate Finance Section 2