Abrams Steel Company Has Very High Operating Leverage Due to the Capital

question 87

Multiple Choice

Abrams Steel Company has very high operating leverage due to the capital intensive nature of the steel business.Abrams' CEO is concerned about the variability in the firm's EPS if sales should drop,and decides to take action.Which of the following will reduce the variability in the firm's EPS for a given change in sales?

• A) The CEO may increase the firm's financial leverage and hence reduce the variability by using non-shareholder money to support the business.
• B) The CEO may decrease the firm's financial leverage, thus lowering the firm's total leverage.
• C) The CEO may increase the firm's total leverage by raising money from the sale of common stock.
• D) The CEO may issue more corporate bonds and use the proceeds to pay off short-term liabilities.

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Definitions:

IRR

Internal Rate of Return; a financial metric used to estimate the profitability of potential investments, calculated as the discount rate that makes the net present value of all cash flows from a particular project equal to zero.

Financial Break-Even

The point at which revenues equal expenses and neither profit nor loss is realized.

Required Rate

Also known as the Required Rate of Return, it is the minimum annual percentage return an investor expects to achieve from an investment.

Discounted Payback

The period of time required to recoup the cost of an investment considering the time value of money through discounted cash flows.