Copyright 2017 Pearson Canada Inc.

1 Copyright © 2017 Pearson Canada Inc.Intermediate Accounting, Vol. 2, 3e (Lo/Fisher) Chapter 12 Non-current Financial Liabilities 12.1 Learning Objective 1 1) Which statement best explains the concept of "leverage"?

• A measure of the efficiency of the company.
• A measure of solvency of the company.
• A measure of the company's operations.
• A measure of the company's debt paying ability.

Answer: B

Diff: 1 Type: MC

Skill: Concept

Objective: 12.1 Describe financial leverage and its impact on profitability.

2) What are "non-current liabilities"?

• Obligations that are expected to be settled in the next operating cycle of the company.
• Obligations that are expected to be settled within the next 12 months.
• Obligations that are expected to be settled more than 12 months after the company's year-end.
• Obligations that are expected to be settled more than 24 months after the company's year-end.

Answer: C

Diff: 2 Type: MC

Skill: Concept

Objective: 12.1 Describe financial leverage and its impact on profitability.

3) Which of the following would be a "non-current liability"?

• Payment due after 3 years, but the company has violated the debt covenants.
• Payment due to a supplier 45 days after year-end for supplies received before year-end.
• Payment due to a supplier in 18 months for goods to be received 3 months after year-end.
• Payment due after 3 years, on which the debt covenants have been not been violated.

Answer: D

Diff: 2 Type: MC

Skill: Concept

Objective: 12.1 Describe financial leverage and its impact on profitability.

4) Which statement is correct about financial leverage?

• It reduces the risk of bankruptcy to the company.
• It reduces the level of risk exposure of the shareholders.
• It quantifies the relationship between the relative level of a firm's debt and its equity base.
• It has nothing to do with the relationship between the relative level of a firm's debt and its equity base.

Answer: C

Diff: 2 Type: MC

Skill: Concept

Objective: 12.1 Describe financial leverage and its impact on profitability.

Intermediate Accounting Vol 2 Canadian 3rd Edition Lo Test Bank Visit TestBankDeal.com to get complete for all chapters

2 Copyright © 2017 Pearson Canada Inc.5) Which statement best explains a "leveraged buyout"?

• A purchase where a small portion of the purchase price is raised by borrowing against the acquired

assets.

• A purchase where a significant portion of the purchase price is raised by borrowing against the

acquired assets.

• A purchase that is deemed too risky from a solvency perspective for the shareholders.
• A purchase that is deemed too risky from a solvency perspective for the bondholders.

Answer: B

Diff: 2 Type: MC

Skill: Concept

Objective: 12.1 Describe financial leverage and its impact on profitability.

6) Which statement is correct about financial leverage?

• Leverage can increase an investor's returns but also increases the risk of loss.
• Leverage can decrease an investor's returns and also decrease the risk of loss.
• Leverage decreases the payments that a company makes on an ongoing basis.
• Leverage decreases the debt level relative to a company's equity base.

Answer: A

Diff: 2 Type: MC

Skill: Concept

Objective: 12.1 Describe financial leverage and its impact on profitability.

7) Which statement is correct about the financial leverage of a company with an equity base of $400,000?

• A company that borrows $150,000 is more leveraged than a company that borrows $250,000.
• A company that borrows $250,000 is more leveraged than a company that borrows $150,000.
• The return on equity of the company is unaffected by the financial leverage.
• The return on equity of the company will be higher if it has a lower leverage.

Answer: B

Diff: 2 Type: MC

Skill: Concept

Objective: 12.1 Describe financial leverage and its impact on profitability.

8) Which statement is not correct about financial leverage for a $300,000 investment versus a $100,000 investment?

• The probability of success is the same under both investment options.
• The payout will be 3 times higher or 3 times lower with the larger investment.
• The probability of success is 3 times greater with the larger investment.
• The larger investment increases the return on equity but also faces a greater potential for loss.

Answer: C

Diff: 2 Type: MC

Skill: Concept

Objective: 12.1 Describe financial leverage and its impact on profitability.

3 Copyright © 2017 Pearson Canada Inc.9) Explain the meaning of financial leverage and leveraged buyout.

Answer:

financial leverage: Quantifies the relationship between the relative level of a firm's debt and its equity base.leveraged buyout: A purchase where a significant part of the purchase price is raised by borrowing against the acquired assets.Diff: 1 Type: SA

Skill: Concept

Objective: 12.1 Describe financial leverage and its impact on profitability.

10) What are some considerations in determining a safe level of debt?Answer: Considerations include:

• the nature of the industry
• degree of operating leverage
• stability of cash flows
• competition
• economic outlook.

Diff: 2 Type: SA

Skill: Concept

Objective: 12.1 Describe financial leverage and its impact on profitability.

4 Copyright © 2017 Pearson Canada Inc.11) Complete the following chart to illustrate how leverage can increase investors' returns while concurrently exposing them to large losses.Facts: Calabria Corporation is a new company and has only one asset, its cash of $105,000 from the sale of common shares.In scenario 1, Calabria invests the $105,000 in a venture that will pay out either $85,000 or $135,000 at the end of one year, depending on the success of the venture.In scenario 2, Calabria borrows $210,000at 7% interest and invests $315,000 in the same project outlined in Scenario 1. The payout will be $255,000 ($85,000 × 3) or $405,000 ($135,000 × 3) because it invests three times as much.Scenario 1(unlevered) Scenario 1(unlevered) Scenario 2 (Levered) Scenario 2 (Levered) Unsuccessful Successful Unsuccessful Successful

Answer:

Scenario 1 (unlevered) Scenario 2 (Levered) Unsuccessful Successful Unsuccessful Successful Opening equity $105,000 $105,000 $105,000 $105,000 Loan proceeds $210,000 $210,000 Investment $105,000 $105,000 $315,000 $315,000 Payout expected $85,000 $135,000 $255,000 $405,000 Repay loan ($210,000) ($210,000) Pay loan interest ($14,700) ($14,700) Closing equity $85,000 $135,000 $30,300 $180,300 Opening equity $105,000 $105,000 $105,000 $105,000 Profit (loss) ($20,000) $30,000 ($74,700) $75,300 Return on opening equity

(ROE) -19% 29% -71% 72%

Diff: 2 Type: ES

Skill: Comp

Objective: 12.1 Describe financial leverage and its impact on profitability.