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Chapter 16:   Operating and Financial Leverage

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1. If by taking on additional debt the firm's securities rating is likely to be lowered, the firm should never take on additional debt.

2. The operating break-even point is the point at which operating profits equal revenues minus operating costs.

3. All other things being the same, if the firm raises funds by selling common stock, it will increase its degree of financial leverage.

4. Preferred stock, like debt, could provide financial leverage to a firm.

5. If EBIT were to remain constant while the firm incurred additional interest expense, the degree of financial leverage would increase.

6. Two firms X and Z, have the same EBIT, but X has a $5 million annual debt-service burden and Z has a $2 million annual debt-service burden. The probability of cash insolvency is greater with X than with Z.

7. If a company has no fixed costs, its DOL equals 1.

8. The EBIT-EPS indifference point between a 100-percent common stock equity alternative and a mix of common stock equity and preferred stock cannot be calculated.

9. A firm has a DOL (at a certain level of output) of 1.75 and a DFL of 2. The degree of total leverage for the firm is 3.5.

10. The greater and more stable the firm's expected future cash flows, the greater its debt capacity.

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