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Unformatted text preview: Chapter 16 Questions and Problems: 1.) Define each of the following: a.) Capital Structure, Business Risk, Financial Risk (Capital Structure) – The manner in which a firm’s assets are financed, normally expressed as the percentage of each type of capital used by the firm which may consist of long-term debt, preferred stock and common stock. The firms mixture of debt and equity. (Business Risk) – The inherent risk associated with operating a firm, prior to the financing decisions. The business risk is the uncertainty inherent in a total risk sense, future operating income, or EBIT. The risk a firm’s common stockholders would face if the firm had no debt. (Financial Risk) – The risk associated with the use of debt financing and any additional risk placed on common stockholders as a result of the decision to finance with debt. b.) Operating Leverage, Financial leverage, Break-even point (Operating Leverage) – Is the extent to which fixed costs are used in a firm’s operations (Financial Leverage) – Is the extent to which fixed income securities such as debt and preferred stock are used in a firm’s capital structure (Break-even Point) – The level of unit sales at which cost equal revenues. In addition breakeven occurs when earnings before interest and taxes (EBIT) equals = (EBIT=0), (When financial costs are not included) If financial costs are included then breakeven occurs when EBIT before taxes = 0) c.) Reserve borrowing capacity – Occurs when a firm uses less debt under normal circumstances than called for by the “Trade-off Theory” 2.) What term refers to the uncertainty inherent in projections of future ROIC? Business Risk 3.) Firms with relatively high nonfinancial fixed costs are said to have a high degree of what? Operating Leverage 4.) “One type of leverage affects both EBIT and EPS. The other type affects only EPS.” Explain this statement The first type Operating leverage affects EBIT and EPS based upon costs associated with a firm operational costs the other Financial leverage affects stockholders by concentrating the firm’s business risk on its stockholders....
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This note was uploaded on 10/19/2010 for the course ACCOUNTING 6660 taught by Professor Mcgrath during the Fall '10 term at Troy.
- Fall '10