Glen Mount Furniture Company
Chapter 5
Discussion Questions
1. Such analysis allows the firm to determine at what level of operations it will break even and to explore the relationship between volume, costs, and profits.
2. A utility is in a stable, predictable industry and therefore can afford to use more financial leverage than an automobile company, which is generally subject to the influences of the business cycle. An automobile manufacturer may not be able to service a large amount of debt when there is a downturn in the economy.
3. A labour-intensive company will have low fixed costs and a correspondingly low break-even point. However, the impact of operating leverage on the firm is small and there will be little magnification of profits as volume increases. A capital-intensive firm, on the other hand, will have a higher break-even point and enjoy the positive influences of operating leverage as volume increases.
4. For break-even analysis based on accounting flows, amortization is considered part of fixed costs. For cash flow purposes, it is eliminated from fixed costs.
The accounting flows perspective is longer-term in nature because we must consider the problems of equipment replacement.
5. Both operating and financial leverage imply that the firm will employ a heavy component of fixed cost resources. This is inherently risky because the obligation to make payments remains regardless of the condition of the company or the economy.
6. Debt can only be used up to a point. Beyond that, financial leverage tends to increase the overall costs of financing to the firm as well as encourage creditors to place restrictions on the firm. The limitations of using financial leverage tend to be greatest in industries that are highly cyclical in nature.
7. The higher the interest rate on new debt, the less attractive financial leverage is to the firm.
8. Operating leverage primarily affects the operating income of the firm. At this
Discussion Questions
1. Such analysis allows the firm to determine at what level of operations it will break even and to explore the relationship between volume, costs, and profits.
2. A utility is in a stable, predictable industry and therefore can afford to use more financial leverage than an automobile company, which is generally subject to the influences of the business cycle. An automobile manufacturer may not be able to service a large amount of debt when there is a downturn in the economy.
3. A labour-intensive company will have low fixed costs and a correspondingly low break-even point. However, the impact of operating leverage on the firm is small and there will be little magnification of profits as volume increases. A capital-intensive firm, on the other hand, will have a higher break-even point and enjoy the positive influences of operating leverage as volume increases.
4. For break-even analysis based on accounting flows, amortization is considered part of fixed costs. For cash flow purposes, it is eliminated from fixed costs.
The accounting flows perspective is longer-term in nature because we must consider the problems of equipment replacement.
5. Both operating and financial leverage imply that the firm will employ a heavy component of fixed cost resources. This is inherently risky because the obligation to make payments remains regardless of the condition of the company or the economy.
6. Debt can only be used up to a point. Beyond that, financial leverage tends to increase the overall costs of financing to the firm as well as encourage creditors to place restrictions on the firm. The limitations of using financial leverage tend to be greatest in industries that are highly cyclical in nature.
7. The higher the interest rate on new debt, the less attractive financial leverage is to the firm.
8. Operating leverage primarily affects the operating income of the firm. At this