FIN 300 MANAGERIAL FINANCE PRACTICE
QUESTIONS AND DETAILED SOLUTIONS
◉ Asymmetric.
Answer: The situation in which outsiders, such as external
shareholders, credits, suppliers, and customers have less and
inferior information about a firm's past, current, and future
conditions and prospects, compared to the firm's managers.
◉ Operating leverage.
Answer: A firm's use of relatively high fixed, as opposed to variable,
operating costs, such as capital-intensive productive processes
instead of labor-intensive methods.
◉ Financial leverage.
Answer: This practice of employing a large portion of fixed-cost
sources of financing, such as debt securities and preferred stock,
exposes a firm to business risk.
◉ Reserve borrowing capacity.
Answer: The financial flexibility available to a firm which allows it to
borrow additional debt capital when needed or desired as a result of
using less than the optimal level of debt in its current capital
structure.
,◉ Signal.
Answer: Management's decision to issue new common stock versus
new debt securities in response to its evaluation of the firm's future
opportunities.
◉ Financial risk.
Answer: The risk to the firm's shareholders resulting from
management's decision to employ fixed-cost financing sources in the
firm's capital structure.
◉ EPS indifference point.
Answer: The level of sales at which a firm;s earnings per share (EPS)
are the same, regardless of which of two alternative capital
structures are compared.
◉ Optimal capital structure.
Answer: The mix of debt, preferred stock, and common stock that
minimizes a firm's weighted average cos of capital.
◉ Capital structure.
Answer: The combination of common equity, preferred stock, and
debt capital used to finance a firm's assets.
,◉ % ΔEBIT / % ΔSales.
Answer: An index for a *specific level* of sales that measures the
effect of change in sales (S) on the firm's operating income (EBIT).
Alternatively, it is an indicator of the riskiness (variability) of a firm's
EBIT to the use of fixed costs (F) in the firm's cost structure.
◉ EBIT / (EBIT - I).
Answer: An index for a specific range of sales that measures the
effect of a change in EBIT on a firm;s earnings per share (ESP). At a
constant level of sales, the DFL value will vary with a change in the
amount of interest expense (I) incurred. This implies that the DFL is
an indicator of a firm's *financial* risk.
◉ (S - VC) / (s - VC - F).
Answer: An index of the firm;s total risk resulting from its use of
operating and financial leverage. Stated differently, it is an indicator
of the consequences for the firm's EPS for its use of *fixed* operating
and financial costs.
◉ An optimal captial structure is characterized by two important
attributes: First, it minimizes the firm's _________, and second, it
maximizes _________, which should make our shareholders very
happy..
Answer: weighted average cost of capital, the value of the firm
, ◉ A firm may use debt and equity financing that differs from its
targeted amounts if its business activities or its industry becomes....
Answer: more risky or more competative
◉ The availability of _________ may prompt a company to borrow or
issue new shares and thereby deviate from its target capital
structure..
Answer: unusually inexpensive sources of capital
◉ Which firm has more financial risk?
Which firm has more business risk?
~Scorecard Corp.~
Total assets: $4,400,000
Total debt : $1,012,000
Expected NOPAT: $1,056,000
Std dev. expected NOPAT: $294,800
~Mob Coffee Inc.~
Total assets: $4,400,000
Total debt : $1,980,000
Expected NOPAT: $1,056,000
QUESTIONS AND DETAILED SOLUTIONS
◉ Asymmetric.
Answer: The situation in which outsiders, such as external
shareholders, credits, suppliers, and customers have less and
inferior information about a firm's past, current, and future
conditions and prospects, compared to the firm's managers.
◉ Operating leverage.
Answer: A firm's use of relatively high fixed, as opposed to variable,
operating costs, such as capital-intensive productive processes
instead of labor-intensive methods.
◉ Financial leverage.
Answer: This practice of employing a large portion of fixed-cost
sources of financing, such as debt securities and preferred stock,
exposes a firm to business risk.
◉ Reserve borrowing capacity.
Answer: The financial flexibility available to a firm which allows it to
borrow additional debt capital when needed or desired as a result of
using less than the optimal level of debt in its current capital
structure.
,◉ Signal.
Answer: Management's decision to issue new common stock versus
new debt securities in response to its evaluation of the firm's future
opportunities.
◉ Financial risk.
Answer: The risk to the firm's shareholders resulting from
management's decision to employ fixed-cost financing sources in the
firm's capital structure.
◉ EPS indifference point.
Answer: The level of sales at which a firm;s earnings per share (EPS)
are the same, regardless of which of two alternative capital
structures are compared.
◉ Optimal capital structure.
Answer: The mix of debt, preferred stock, and common stock that
minimizes a firm's weighted average cos of capital.
◉ Capital structure.
Answer: The combination of common equity, preferred stock, and
debt capital used to finance a firm's assets.
,◉ % ΔEBIT / % ΔSales.
Answer: An index for a *specific level* of sales that measures the
effect of change in sales (S) on the firm's operating income (EBIT).
Alternatively, it is an indicator of the riskiness (variability) of a firm's
EBIT to the use of fixed costs (F) in the firm's cost structure.
◉ EBIT / (EBIT - I).
Answer: An index for a specific range of sales that measures the
effect of a change in EBIT on a firm;s earnings per share (ESP). At a
constant level of sales, the DFL value will vary with a change in the
amount of interest expense (I) incurred. This implies that the DFL is
an indicator of a firm's *financial* risk.
◉ (S - VC) / (s - VC - F).
Answer: An index of the firm;s total risk resulting from its use of
operating and financial leverage. Stated differently, it is an indicator
of the consequences for the firm's EPS for its use of *fixed* operating
and financial costs.
◉ An optimal captial structure is characterized by two important
attributes: First, it minimizes the firm's _________, and second, it
maximizes _________, which should make our shareholders very
happy..
Answer: weighted average cost of capital, the value of the firm
, ◉ A firm may use debt and equity financing that differs from its
targeted amounts if its business activities or its industry becomes....
Answer: more risky or more competative
◉ The availability of _________ may prompt a company to borrow or
issue new shares and thereby deviate from its target capital
structure..
Answer: unusually inexpensive sources of capital
◉ Which firm has more financial risk?
Which firm has more business risk?
~Scorecard Corp.~
Total assets: $4,400,000
Total debt : $1,012,000
Expected NOPAT: $1,056,000
Std dev. expected NOPAT: $294,800
~Mob Coffee Inc.~
Total assets: $4,400,000
Total debt : $1,980,000
Expected NOPAT: $1,056,000
