Chapter 10 Practice Exam Q&amp;A

# Chapter 10 Practice Exam Q&amp;A - Chapter 10 Test...

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Chapter 10 Test Questions

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Question 1 Specific Mills is reviewing its financial condition. Sales are \$18 million from which the firm generated an operating profit of \$5,220,000 and a net profit after tax of \$2,622,000. The firm’s interest expense was \$850,000 and total variable cost was \$8,000,000. The firm is expecting an increase in sales of 7%. Based on this data, what would you expect the percentage change in net income to be? a. 7%
Answer Question 1 First lets find the DOL = (Sales – VC) / EBIT = (\$18,000,000 - \$8,000,000) / \$5,220,000 = 1.92. Now lets find the DFL = EBIT / (EBIT – I) = \$5,220,000 / (\$5,220,000 - \$850,000) = 1.19. Then DCL = DOL * DFL = 1.92 * 1.19 = 2.28. To get the answer we take the DCL and multiply by the increase in sales or 7% * 2.28 = 16% Answer : D

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Question 2 An analyst is comparing two firms in the same industry. One of the firms has high operating leverage and the other has low operating leverage. Which of the following is true of the firm with the higher operating leverage? a. The firm will have more volatile sales b. The firm will have lower credit standards c. The firm will have a lower cost of borrowing d. The firm will have more volatile operating profits
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