Question

State whether the following statements are true or false and support it with reasons .

1. Operating leverage explains the firm’s ability to pay the amount of debt to the lender.

(                    )

2. The firm’s ROE and ROA are different, this implies that the firm is Financed entirely with common equity. (                        )
3. Financial Leverage reflects the amount of fixed operating cost used in the capital structure. (                      )
4. The financial leverage explains just the negative effect of the debt financing on the shareholders' profit maximization. (                    )
5. Return on asset rises (or decrease) depending on the net profit margin and total asset turnover. (                   )
6. Within a leveraged corporation, if the ROA was 12 %, then its ROE must be to 12%. (                 )
7. The additional finance needs of the firm are affecting by retained earnings and net profit margin. (             )
8. Operating leverage reflects the financial cost used in the capital structure of the firm.

(                   )

9. Capital Budgeting is a short-term decision, include huge expenditures of new fixed assets.

(                    )

10. The process of going from the present value (PV) to the future value (FV) is called the discounting process. (                  )

Answer 1

1) False

Operating leverage explains the impact of change in profits with the change in the level of sales. It is a measure of fixed cost in the operating cost structure.

2) False

If ROE and ROA are different that means there is leverage, debt in the capital structure because ROE = ROA * financial leverage.

3) False

Financial leverage explains as to how much of total asset is financed with equity.

4) False

Financial leverage explains the impact of debt level and it can be positive as well as negative depending on the return.

5) True

ROA according to du Pont is equal to net profit margin multiplied by asset turnover.

6) False

If the firm is leveraged ROE and ROA can be different because ROE = ROA * financial leverage

7) True

Additional financing needed are affected by retained earning and net profit margin, higher these factors lower would be the additional funds needed.

8) False

Operating leverage reflects the fixed cost in the operating cost structure.

9) False

Capital budgeting is a long-term capital investment decision.

10) False

The process of going from future value to present value is called discounting process.