What is operating leverage?
a) The degree to which a company uses debt financing
b) The extent to which a company relies on fixed costs
in its cost structure
c) The difference between gross profit and operating
profit
d) The ratio of current assets to current liabilities
Answer: b) The extent to which a company relies on fixed
costs in its cost structure.
Which of the following statements is true regarding
high operating leverage?
a) It magnifies the impact of changes in sales on net
income
b) It reduces the company's financial risk
c) It is always preferred over low operating leverage
d) It increases the company's variable costs
Answer: a) It magnifies the impact of changes in sales
on net income.
The degree of operating leverage (DOL) can be
calculated as:
a) Contribution Margin / Fixed Costs
b) Sales Revenue / Variable Costs
c) Sales Revenue / Contribution Margin
d) Fixed Costs / Net Income
Answer: a) Contribution Margin / Fixed Costs
A company with a DOL of 3 experiences a 10% increase
in sales. What will be the percentage change in its operating income?
a) 10%
b) 30%
c) 20%
d) 3%
Answer: b) 30%
If a company's DOL is 1, it implies that:
a) The company has no fixed costs in its cost
structure
b) The company's net income is zero
c) The company's contribution margin is equal to its
fixed costs
d) The company is not affected by changes in sales
Answer: d) The company is not affected by changes in
sales.
Which of the following factors is likely to increase a
company's operating leverage?
a) Reducing fixed costs and increasing variable costs
b) Increasing fixed costs and reducing variable costs
c) Increasing both fixed and variable costs
proportionally
d) Eliminating all costs except variable costs
Answer: b) Increasing fixed costs and reducing
variable costs.
The breakeven point occurs when:
a) Total revenue is equal to total expenses
b) Total revenue is greater than total expenses
c) Total revenue is less than total expenses
d) Total revenue is equal to the contribution margin
Answer: a) Total revenue is equal to total expenses.
A company with low operating leverage is likely to
have:
a) Higher financial risk
b) Lower fixed costs
c) Higher variable costs
d) Lower breakeven point
Answer: b) Lower fixed costs.
Operating leverage is most beneficial for a company
when:
a) Sales are stable and predictable
b) Sales fluctuate widely
c) The company has a high level of debt
d) The company has low variable costs
Answer: a) Sales are stable and predictable.
Which financial metric measures a company's ability to
cover its fixed costs with its contribution margin?
a) Current Ratio
b) Debt-to-Equity Ratio
c) Operating Margin
d) Degree of Operating Leverage (DOL)
Answer: d) Degree of Operating Leverage (DOL)
Operating leverage and break-even analysis are both
concerned with:
a) Maximizing profits
b) Assessing financial risk
c) Analyzing sales performance
d) Evaluating cost structures
Answer: d) Evaluating cost structures
The degree of operating leverage (DOL) is directly
related to the company's:
a) Fixed costs
b) Variable costs
c) Total costs
d) Sales revenue
Answer: a) Fixed costs
In break-even analysis, the break-even point is where:
a) Sales revenue equals variable costs
b) Sales revenue equals total costs
c) Sales revenue equals fixed costs
d) Sales revenue equals contribution margin
Answer: b) Sales revenue equals total costs
How does operating leverage affect the break-even
point of a company?
a) High operating leverage leads to a lower break-even
point
b) High operating leverage leads to a higher
break-even point
c) Operating leverage has no effect on the break-even
point
d) The break-even point is solely determined by sales
volume
Answer: b) High operating leverage leads to a higher
break-even point
A company with a high degree of operating leverage
will have:
a) A low contribution margin ratio
b) A high contribution margin ratio
c) A low fixed costs-to-variable costs ratio
d) A high variable costs-to-fixed costs ratio
Answer: b) A high contribution margin ratio
When a company's operating leverage increases, its
profitability:
a) Decreases at the break-even point
b) Increases at the break-even point
c) Remains constant at the break-even point
d) Cannot be determined without additional information
Answer: b) Increases at the break-even point
The break-even point can be calculated as:
a) Fixed Costs / Contribution Margin
b) Contribution Margin / Fixed Costs
c) Sales Revenue / Variable Costs
d) Total Costs / Sales Revenue
Answer: a) Fixed Costs / Contribution Margin
Which statement is true regarding the relationship between
operating leverage and risk?
a) High operating leverage reduces financial risk
b) Low operating leverage increases financial risk
c) Operating leverage and financial risk are unrelated
d) Both high and low operating leverage increase financial
risk
Answer: b) Low operating leverage increases financial
risk
If a company's degree of operating leverage is 2.5, a
10% increase in sales will result in a:
a) 2.5% increase in net income
b) 25% increase in net income
c) 10% increase in net income
d) 5% increase in net income
Answer: b) 25% increase in net income
The break-even analysis is useful for:
a) Identifying the point where losses occur
b) Assessing the impact of variable costs on
profitability
c) Evaluating the company's capital structure
d) Calculating the company's market share
Answer: a) Identifying the point where losses occur
8.3 Financial Leverage
MCQs
Financial leverage refers to:
a) The use of debt financing to increase returns for
shareholders
b) The use of equity financing to reduce financial
risk
c) The combination of fixed and variable costs in a
company's cost structure
d) The process of maximizing sales revenue for a
business
Answer: a) The use of debt financing to increase
returns for shareholders
The primary advantage of financial leverage is that
it:
a) Increases a company's fixed costs
b) Reduces the company's cost of capital
c) Reduces the potential for higher returns on
investment
d) Eliminates the need for equity financing
Answer: b) Reduces the company's cost of capital
The degree of financial leverage (DFL) measures the
sensitivity of:
a) Sales volume to changes in net income
b) Net income to changes in sales volume
c) Fixed costs to changes in variable costs
d) Debt to equity ratio to changes in asset turnover
Answer: b) Net income to changes in sales volume
Which statement about financial leverage is true?
a) It has no impact on a company's profitability
b) It is always favorable and should be maximized
c) It increases the risk of bankruptcy for a company
d) It is unrelated to a company's capital structure
Answer: c) It increases the risk of bankruptcy for a
company
The breakeven point for a leveraged company is
generally:
a) Higher than for an unleveraged company
b) Lower than for an unleveraged company
c) The same as for an unleveraged company
d) Unaffected by financial leverage
Answer: a) Higher than for an unleveraged company
The financial leverage ratio is calculated as:
a) Total Debt / Total Equity
b) EBIT / Total Equity
c) Total Equity / Total Assets
d) EBIT / EBITDA
Answer: a) Total Debt / Total Equity
How does an increase in financial leverage impact a
company's earnings per share (EPS)?
a) EPS increases proportionally with financial leverage
b) EPS remains unchanged regardless of financial
leverage
c) EPS decreases proportionally with financial
leverage
d) EPS is not affected by financial leverage
Answer: c) EPS decreases proportionally with financial
leverage
High financial leverage is most beneficial for a
company when:
a) Sales are declining
b) Sales are highly volatile
c) Sales are steadily increasing
d) Sales remain constant
Answer: c) Sales are steadily increasing
A company with a high degree of financial leverage is
more susceptible to changes in:
a) Fixed costs
b) Variable costs
c) Sales volume
d) Net income
Answer: c) Sales volume
Financial leverage can magnify a company's:
a) Fixed costs
b) Operating risk
c) Variable costs
d) Return on equity
Answer: d) Return on equity
8.4 Combined Leverage
Combined leverage refers to the:
a) Total amount of debt and equity a company uses for
financing
b) Sum of operating leverage and financial leverage
c) Ratio of fixed costs to variable costs in a
company's cost structure
d) Process of diversifying a company's investment
portfolio
Answer: b) Sum of operating leverage and financial
leverage
What does combined leverage indicate about a company's
cost structure?
a) The proportion of debt in the company's capital structure
b) The proportion of fixed costs in the company's cost
structure
c) The efficiency of the company's production process
d) The extent to which a company relies on variable
costs
Answer: b) The proportion of fixed costs in the
company's cost structure
The degree of combined leverage (DCL) is a measure of:
a) The company's total debt-to-equity ratio
b) The company's total fixed costs relative to its
total costs
c) The company's ability to generate sales revenue
d) The company's degree of financial risk
Answer: b) The company's total fixed costs relative to
its total costs
A company with high combined leverage is more
sensitive to changes in:
a) Sales revenue
b) Operating income
c) Financial expenses
d) Equity financing
Answer: a) Sales revenue
How is combined leverage affected when a company
increases its use of debt financing?
a) Combined leverage decreases
b) Combined leverage remains unchanged
c) Combined leverage increases
d) Combined leverage becomes negative
Answer: c) Combined leverage increases
The break-even point for a company can be influenced
by changes in:
a) The contribution margin
b) The fixed costs
c) The financial leverage
d) The degree of operating leverage
Answer: b) The fixed costs
A company with a low degree of combined leverage will
have a:
a) High break-even point
b) Low break-even point
c) Stable net income
d) High level of financial risk
Answer: a) High break-even point
What does a negative degree of combined leverage
indicate for a company?
a) The company is experiencing losses
b) The company has no fixed costs
c) The company has no variable costs
d) The company's cost structure is balanced
Answer: a) The company is experiencing losses
A decrease in fixed costs and an increase in variable
costs would likely result in:
a) An increase in combined leverage
b) A decrease in combined leverage
c) No change in combined leverage
d) A negative degree of combined leverage
Answer: b) A decrease in combined leverage
The degree of combined leverage (DCL) can be calculated
as:
a) Percentage change in operating income / Percentage
change in sales
b) Percentage change in sales / Percentage change in
operating income
c) Percentage change in fixed costs / Percentage
change in sales
d) Percentage change in sales / Percentage change in
fixed costs
Answer: a) Percentage change in operating income /
Percentage change in sales
