Leverage, Capital Structure, and Risk & Return Worksheet

Operating leverage will be the highest when a firm has:

• High variable cost and low fixed cost

• Low contribution margin

• High fixed operating costs

• High financial leverage

A firm has Contribution = 6,00,000 and EBIT = 2,00,000. Degree of Operating Leverage is:

• 2

• 3

• 4

• 6

Financial leverage exists primarily due to the presence of:

• Fixed operating costs

• Fixed financial charges

• Variable dividend policy

• Retained earnings

• 5

• 6

• 1.5

• Cannot be determined

Combined leverage is best described as sensitivity of:

• EBIT to sales

• EPS to EBIT

• EPS to sales

• Net profit to contribution

According to the NI approach, the value of the firm:

• Is independent of capital structure

• Decreases with leverage

• Increases with leverage

• Is maximum at zero debt

NI approach assumes cost of equity:

• Decreases with leverage

• Increases linearly

• Remains constant

• Is irrelevant

Under NOI approach, overall capitalization rate (Ko) is:

• Variable

• Minimum at optimal capital structure

• Constant

• Dependent on tax rate

NOI approach implies that increase in leverage will:

• Reduce cost of equity

• Increase cost of equity

• Reduce overall cost of capital

• Not affect cost of equity

Which approach supports irrelevance of capital structure?

• NI

• NOI

• Traditional

• EBIT–EPS