CFA® Level 1: CFA® Level 1 Exam Prep

D

If no debt were used, there will be no interest charges, which is included in net income but not EBIT.

The correct answer to the question is option E: None of these statements are correct.

Let's analyze each statement to understand why it is incorrect:

A. All else being equal, an increase in a firm's fixed costs will decrease its degree of operating leverage.

This statement is incorrect. Operating leverage measures the relationship between a firm's fixed costs and its variable costs. Specifically, it indicates the percentage change in operating income (EBIT) resulting from a percentage change in sales. An increase in fixed costs will increase the degree of operating leverage because a larger proportion of the costs are fixed, making the firm more sensitive to changes in sales.

B. All of these statements are correct.

This statement is incorrect because at least one of the statements must be incorrect based on the given answer choices.

C. Firms that have large fixed costs and low variable costs have a higher degree of financial leverage than do firms with low fixed costs and high variable costs.

This statement is incorrect. Financial leverage refers to the use of debt financing by a firm. It is unrelated to the composition of fixed and variable costs. The degree of financial leverage is determined by the amount of debt in the firm's capital structure, not by the fixed and variable costs.

D. If a firm's net income rises 10 percent every time its EBIT rises 10 percent, this implies the firm has no debt outstanding.

This statement is incorrect. The relationship between net income and EBIT (earnings before interest and taxes) is unrelated to the presence or absence of debt. Net income depends on various factors, including interest expenses, taxes, and other non-operating items, in addition to operating income (EBIT).

E. None of these statements are correct.

This statement is correct based on the analysis of the previous statements.

In summary, option E is the correct answer because none of the statements provided are correct.