match the correct description with the correct term. Descriptions Terms The level and nature of risk attributable to a firm’s activities and operations, and ignoring the risks associated with the firm’s capital structure. Asymmetric information The situation in which outsiders, such as external shareholders, credits, suppliers, and customers have less and inferior information about a firm’s past, current, and future conditions and prospects, compared to the firm’s managers. Business risk The extent to which a firm’s cost structure contains a large proportion of fixed costs, which raises its level of business risk if the firm’s sales decline. Capital structure This practice of employing a large proportion of fixed-cost sources of financing, such as debt securities and preferred stock, exposes a firm’s stockholders to more business risk. EPS indifference point The ability of a firm to borrow money at a reasonable cost when good investment opportunities arise because it currently less debt than that suggested by its optimal capital structure. Financial leverage An action taken by a firm’s management that provides clues to investors about how management views the firm’s prospects. Financial risk The risk that is borne solely by the firm’s shareholders, and results from a firm’s decision to finance its assets using fixed-cost sources of capital, including debt securities and preferred stock. Operating leverage The level of sales at which a firm’s earnings per share (EPS) are the same, regardless of which of two alternative capital structures are compared. Optimal capital structure The mix of debt, preferred stock, and common stock that maximizes the price of the firm’s common stock. Reserve borrowing capacity The mix of debt, preferred stock, and common stock that finances a firm’s assets. Signal

Auditing: A Risk Based-Approach (MindTap Course List)

11th Edition

ISBN:9781337619455

Author:Karla M Johnstone, Audrey A. Gramling, Larry E. Rittenberg

Publisher:Karla M Johnstone, Audrey A. Gramling, Larry E. Rittenberg

Chapter10: Auditing Cash, Marketable Securities, And Complex Financial Instruments

Section: Chapter Questions

Problem 40CYBK

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match the correct description with the correct term.

Descriptions	Terms
The level and nature of risk attributable to a firm’s activities and operations, and ignoring the risks associated with the firm’s capital structure.	Asymmetric information
The situation in which outsiders, such as external shareholders, credits, suppliers, and customers have less and inferior information about a firm’s past, current, and future conditions and prospects, compared to the firm’s managers.	Business risk
The extent to which a firm’s cost structure contains a large proportion of fixed costs, which raises its level of business risk if the firm’s sales decline.	Capital structure
This practice of employing a large proportion of fixed-cost sources of financing, such as debt securities and preferred stock, exposes a firm’s stockholders to more business risk.	EPS indifference point
The ability of a firm to borrow money at a reasonable cost when good investment opportunities arise because it currently less debt than that suggested by its optimal capital structure.	Financial leverage
An action taken by a firm’s management that provides clues to investors about how management views the firm’s prospects.	Financial risk
The risk that is borne solely by the firm’s shareholders, and results from a firm’s decision to finance its assets using fixed-cost sources of capital, including debt securities and preferred stock.	Operating leverage
The level of sales at which a firm’s earnings per share (EPS) are the same, regardless of which of two alternative capital structures are compared.	Optimal capital structure
The mix of debt, preferred stock, and common stock that maximizes the price of the firm’s common stock.	Reserve borrowing capacity
The mix of debt, preferred stock, and common stock that finances a firm’s assets.	Signal

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