Question

Terms Descriptions The level and nature of risk attributable to a firm's activities and operations, and ignoring the risks associated with the firm's capital structure The situation in which managers have different, and usually better, information about their firm's past, current, and future conditions and prospects, compared to outsiders, such as external investors, creditors, suppliers, and customers A firm's use of relatively high fixed, as opposed to variable, operating costs, such as capital-intensive productive processes instead of labor-intensive methods This practice of employing a large proportion of fixed-cost sources of financing, such as debt securities and preferred stock, exposes a firm's stockholders to more business risk. The financial flexibility available to a firm which allows it to borrow additional debt capital when needed or desired as a result of using less than the optimal level of debt in its current capital structure. An action taken by a firm's management that provides clues to investors about how management views the firm's prospects. The risk to the firm's shareholders resulting from management's decision to employ fixed-cost financing sources in the firm's capital structure The level of sales at which the firm's earnings per share (EPS) is the same, and there is no advantage to using more debt or more equity in the firm's capital structure. The mix of debt, preferred stock, and common stock that maximizes the price of the firm's common stock. Screenshot The combination of common equity, preferred stock, and debt capital used to finance a firm's assets. In making capital structure decisions, managers must manage the firm's level of operating leverage and financial leverage, and the firm's exposure to business and financial risks. This requires knowledge of a firm's degree of operating leverage (DOL), financial leverage (DFL), and total leverage (DTL). Complete the following table by identifying the correct formula and completing the interpretative statement. Interpretation Formula Degree of operating leverage (DOL) An index for a (S) on the firm's operating income (EBIT). Alternatively, it is an indicator of the riskiness (variability) of a firm's EBIT to the use of fixed costs (F) in the firm's cost structure ▼ of sales that measures the effect of a change in sales Degree of financial leverage (DFL) An index for a specific range of sales that measures the effect of a change in EBIT on a firm's earnings per share (EPS). At a constant level of sales, the DFL value will vary with a change in the amount of interest expense (I) incurred. This implies that the DFL is an indicator of a firm's risk Degree of total leverage (DTL) An index of the firm's total risk resulting from its use of operating and financial leverage Stated differently, it is an indicator of the consequences for the firm's EPS for its use of ▼ operating and financing costs. Gra Screenshot Save&Continue Continue without saving

Answer 1

Part 1:

1. Business risk

2. Asymmetric information

3. Operating leverage

4. Financial leverage

5. Reserve borrowing capacity

6. Signal hypothesis

7. Financial risk

8. EPS indifference point

9.Optimal capital structure

10. Capital structure

Part 2:

1. Degree of operating leverage = % change in EBIT / % change in sales

Blank - specific level

2. Degree of financial leverage = EBIT / (EBIT - Interest)

Blank - financial

3. Total leverage = (Sales - Variable Cost ) / ( Sales - Variable costs - Fixed costs)

Blank - fixed