Corporate Finance MCQ - Corporate Finance Section 2

36 The cost of equity capital is equal to the:

The cost of equity capital is the rate of return required by stockholders.

37 Using the dividend discount model, the cost of equity capital for a company which will pay a dividend of $2.00 next year, has a payout ratio of 35 percent, a return on equity (ROE) of 15 percent, and current stock price of $40, is:

Using the sustainable growth calculation, the growth rate is calculated as:
g = (1 – Dividend payout ratio) (Return on Equity)
= (1 – 0.35) (15%) = 9.8%
Re = (D1 / P0) + g = ($2.00 / $40) + 9.80% = 14.75%.

38 The unit contribution margin for a product is $12. A firm’s fixed operating cost is $600,000. The degree of operating leverage (DOL) is most likely the lowest at which of the following production levels (in units)?

DOL = (quantity * contribution margin) / [(quantity * contribution margin) – fixed costs]
DOL (100,000 units) =($12 * 100,000) / [($12 * 100,000) – 600,000] = 2.00
DOL (200,000 units) = ($12 * 200,000) / [($12 * 200,000) – 600,000] = 1.33
DOL (300,000 units) = ($12 * 300,000) / [($12 * 300,000) – 600,000] = 1.20
The DOL is lowest at the 300,000 unit production level.

39 While analyzing the impact of the economy’s growth on the revenues generated by Com Point, Mr. Shah recorded earnings of Rs.200 billion and expected them to grow by 10% due to the increasing demand. To evaluate the impact of this, he wants to calculate the operating leverage with the following data:

Sales in 2009	22.5 million computers
Average price per computer	Rs.90,000
Fixed costs for the period	Rs.33 billion
Variable costs per computer	Rs.70,000

What is the degree of operating leverage (DOL)

DOL = [Q (P - V)] / [Q (P - V) - F]
=[22.5 million (Rs.90,000 – Rs.70,000)] / [22.5 million (Rs.90,000 – Rs.70,000) – 33 billion] = 1.08
For a 10 percent increase in computers sold, operating income increases by 1.08 * 10% = 10.08%.

40 Degree of operating leverage is best described as a measure of the sensitivity of:

The degree of operating leverage is the elasticity of operating earnings with respect to the number of units produced and sold. As elasticity, the degree of operating leverage measures the sensitivity of operating earnings to a change in the number of units produced and sold.