FINANCIAL MARKETS DRILL 2 [LEVERAGE & CAPITAL STRUCTURE]

_____ results from the use of fixed cost assets or funds to magnify returns to the firms

_____ leverage is concerned with the relationship between sales and earnings before interest and taxes

_____ leverage is concerned with the relationship between sales revenue and earnings per share

_____ leverage is concerned with the relationship between earnings before interest and taxes and earnings per share

Higher financial leverage causes ___ to increase more for a given increase in _____

• EBIT; Sales

• EPS; Sales

• EPS; EBIT

• EBIT; EPS

With the existence of fixed operating costs; a decrease in sales will result in ______ EBIT

• Proportional increase

• An equal increase

• A less than proportional decrease

• A more than proportional decrease

_____ risk is the risk of being unable to cover operating cost

_____ risk is the risk of being unable to cover financial cost

In order to enhance the wealth of the stockholders and to send positive signals to the market, corporations generally raise funds using the following order:

• Retained earnings, equity, debt

• Retained earnings, debt, equity

• Debt, retained earnings, equity

• Equity, retained earnings, debt

A debt is substituted for equity in the capital structure and debt ratio increases, all of the following statements about the component of cost of capital are true except

• The cost of equity continually increases

• The cost of debt continually increases

• The overall cost of capital first decline, reaches a minimum and then rises again

• The overall cost of capital continually increases