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CFA CFA I Exam
CFA Level I Chartered Financial Analyst (Page 54 )

Updated On: 26-Jan-2026
Page 54 of 793
PDF with 3960 Questions

Which of the following statements is most correct?

  1. None of these answers are correct.
  2. An increase in fixed costs, (holding sales and variable costs constant) will reduce the company's degree of operating leverage.
  3. If the company has no debt outstanding, then its degree of total leverage equals its degree of operating leverage.
  4. All of these answers are correct.
  5. An increase in interest expense will reduce the company's degree of financial leverage.

Answer(s): C

Explanation:

The degree of financial leverage is the percentage change in EPS that results form a given percentage change in earnings before interest and taxes. If a firm has no debt outstanding the degree of financial leverage would be 1.0.



Which of the following firm's earnings per share (EPS) figure would be least sensitive to a percentage change in Earnings Before Interest and Taxes (EBIT)?
Firm A
EBIT: $6,800,000
Interest Paid: $505,000
Total Operating Expenses: $80,000,000
Fixed Operating Expenses: $50,250,000
Firm B
EBIT: $20,000,000
Interest Paid: $600,000

Total Operating Expenses: $40,000,000
Fixed Operating Expenses: $30,250,000
Firm C
EBIT: $50,500,000
Interest Paid: $3,500,000
Total Operating Expenses: $66,000,000
Fixed Operating Expenses: $30,750,000
Firm D
EBIT: $49,700,000
Interest Paid: $7,750,000
Total Operating Expenses: $90,000,000
Fixed Operating Expenses: $75,000,000
Firm E
EBIT: $43,000,000
Interest Paid: $7,000,000
Total Operating Expenses: $85,000,000
Fixed Operating Expenses: $60,500,000

  1. The answer cannot be determined from the information provided.
  2. Firm B
  3. Firm A
  4. Firm D
  5. Firm C
  6. Firm E

Answer(s): B

Explanation:

This question is asking you to calculate the Degree of Financial Leverage for each company. The Degree of Financial Leverage (DFL) measures the percentage change in EPS that results from a given percentage change in EBIT. Financial Leverage is the second component of total leverage, along with Operating Leverage.
The equation used to calculate the Degree of Financial Leverage is as follows: {DFL = [EBIT/(EBIT - Interest Paid)]}. As companies incorporate more debt in their capital structure, their EPS figure will become more sensitive to fluctuations occurring from interest payments, and this is evidenced by an increase in the Degree of Financial Leverage. In this example, Firm B has the lowest DFL with a figure of 1.031. In light of this information, it can be concluded that firm B has an EPS figure which is the least sensitive to a given change in EBIT. When calculating the DFL figure, remember that the answer can never be less than one, and can never be negative. In a situation where the company under examination has zero debt, and no preferred stock dividends (and therefore no interest expense for purposes of the DFL equation), the DFL would be equal to one. It is important note to remember is that in calculating the Degree of Financial Leverage, dividend payments to preferred stockholders should be included in the interest expense figure. Operating expenses are not factored into the DFL calculation, rather are used in the determination of Operating Leverage.



The length of time required for an investment's net revenues to cover its cost is known as ________.

  1. Optimal Capital Structure
  2. Net Present Valuing
  3. Capital Budgeting
  4. Payback Period
  5. Weighted Average Cost of Capital (WACC)

Answer(s): D

Explanation:

Payback Period is defined as the length of time required for an investment's net revenues to cover its cost.



Which of the following is/are true about project risk analysis?

  1. Stand-alone risk is measured by the variability of the projects expected returns.
    II. Corporate risk measures the impact of the project's risk on the company's stock price variability.
    III. Market risk measures the impact of the project on the stock's unsystematic risk.
  2. I & II
  3. II & III
  4. III only
  5. I, II & III
  6. II only
  7. I only

Answer(s): F

Explanation:

Standalone risk evaluates the risk of a project ignoring all portfolio aspects by looking at the variability of the project's projected returns. The corporate risk of a project is measured by the project's impact on the uncertainty about the firm's future earnings. The market risk of a project is measured by the project's impact on the systematic risk of the firm's stock.



Scenario analysis ignores:

  1. the range of likely values that key variables can take.
  2. changes in some of the key variables.
  3. effect on the NPV of changes in project variables.
  4. none of these answers.

Answer(s): D

Explanation:

It is the Sensitivity Analysis that ignores the range of likely values that key variables can take. This is rectified using Scenario Analysis.



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