# Daily Archives: March 4, 2021

## Calculate the firm’s earnings before interest and taxes (EBIT) for sales of 10,000 units.

Stewart Industries sells its finished product for \$9 per unit. Its fixed operating costs are \$20,000, and the variable operating cost per unit is \$5.

a. Calculate the firm’s earnings before interest and taxes (EBIT) for sales of 10,000 units.

b. Calculate the firm’s EBIT for sales of 8,000 and 12,000 units, respectively.

c. Calculate the percentage changes in sales (from the 10,000-unit base level) and

associated percentage changes in EBIT for the shifts in sales indicated in part b.

d. On the basis of your findings in part c, comment on the sensitivity of changes in

EBIT in response to changes in sales.

## Calculate the operating breakeven point in units.

Grey Products has fixed operating costs of \$380,000, variable operating costs of \$16 per unit, and a selling price of \$63.50 per unit.

a. Calculate the operating breakeven point in units.

b. Calculate the firm’s EBIT at 9,000, 10,000, and 11,000 units, respectively. c. With 10,000 units as a base, what are the percentage changes in units sold and EBIT as sales move from the base to the other sales levels used in part b?

d. Use the percentages computed in part c to determine the degree of operating leverage (DOL).

e. Use the formula for degree of operating leverage to determine the DOL at 10,000 units.

## Should Max take on the additional loan payment?

Max Small has outstanding school loans that require a monthly payment of \$1,000. He needs to buy a new car for work and estimates that this purchase will add \$350 per month to his existing monthly obligations. Max will have \$3,000 available after meeting all his monthly living (operating) expenses. This amount could vary by plus or minus 10%.

a. To assess the potential impact of the additional borrowing on his financial leverage, calculate the DFL in tabular form for both the current and proposed loan payments using Max’s available \$3,000 as a base and a 10% change.

b. Can Max afford the additional loan payment?

c. Should Max take on the additional loan payment?

## Calculate the firm’s degree of total leverage (DTL).

Carolina Fastener, Inc., makes a patented marine bulkhead latch that wholesales for \$6.00. Each latch has variable operating costs of \$3.50. Fixed operating costs are \$50,000 per year. The firm pays \$13,000 interest and preferred dividends of \$7,000 per year. At this point, the firm is selling 30,000 latches per year and is taxed at a rate of 40%.

a. Calculate Carolina Fastener’s operating breakeven point.

b. On the basis of the firm’s current sales of 30,000 units per year and its interest

and preferred dividend costs, calculate its EBIT and earnings available for common.

c. Calculate the firm’s degree of operating leverage (DOL).

d. Calculate the firm’s degree of financial leverage (DFL).

e. Calculate the firm’s degree of total leverage (DTL).

f. Carolina Fastener has entered into a contract to….

## Calculate the ratio for requirement 1.

Kirsten Neal is interested in purchasing a new house given

that mortgage rates are low. Her bank has specific rules regarding an applicant’s

ability to meet the contractual payments associated with the requested debt.

Kirsten must submit personal financial data for her income, expenses, and existing

installment loan payments. The bank then calculates and compares certain ratios to predetermined allowable values to determine if it will make the requested loan. The

requirements are as follows:

(1) Monthly mortgage payments , 28% of monthly gross (before-tax) income.

(2) Total monthly installment payments (including the mortgage payments) , 37%

of monthly gross (before-tax) income.

Kirsten submits the following personal financial data:

a. Calculate the ratio for requirement 1.

b. Calculate the ratio for requirement 2.

c. Assuming that….

## Compare your findings in parts b and c, and comment on the effect of the reduction of debt to zero on the firm’s financial risk.

1. Tower Interiors has made the forecast of sales shown in the following table. Also given is the probability of each level of sales.

The firm has fixed operating costs of \$75,000 and variable operating costs equal to

70% of the sales level. The company pays \$12,000 in interest per period. The tax rate is 40%.

a. Compute the earnings before interest and taxes (EBIT) for each level of sales.

b. Compute the earnings per share (EPS) for each level of sales, the expected EPS,

the standard deviation of the EPS, and the coefficient of variation of EPS, assuming

that there are 10,000 shares of common stock outstanding.

c. Tower has the opportunity to reduce its leverage to zero and pay no interest. This change will….

## Discuss the leverage and risk aspects of each structure.

Data-Check is considering two capital structures.

The key information is shown in the following table. Assume a 40% tax rate.

a. Calculate two EBIT–EPS coordinates for each of the structures by selecting any

two EBIT values and finding their associated EPS values.

b. Plot the two capital structures on a set of EBIT–EPS axes.

c. Indicate over what EBIT range, if any, each structure is preferred.

d. Discuss the leverage and risk aspects of each structure.

e. If the firm is fairly certain that its EBIT will exceed \$75,000, which structure

would you recommend? Why?

## Calculate earnings per share for each level of indebtedness.

Medallion Cooling Systems, Inc., has total assets of \$10,000,000, EBIT of \$2,000,000, and preferred dividends of \$200,000 and is taxed at a rate of 40%. In an effort to determine the optimal capital structure, the firm has assembled data on the cost of debt, the number of shares of common stock for various levels of indebtedness, and the overall required return on investment:

a. Calculate earnings per share for each level of indebtedness.

b. Use Equation 12.12 and the earnings per share calculated in part a to calculate a

price per share for each level of indebtedness.

c. Choose the optimal capital structure. Justify your choice.

## estimate the share value for each of the capital structures being considered.

Country Textiles, which has fixed operating costs of \$300,000 and variable operating costs equal to 40% of sales, has made the following three sales estimates, with their probabilities noted.

The firm wishes to analyze five possible capital structures: 0%, 15%, 30%, 45%,

and 60% debt ratios. The firm’s total assets of \$1 million are assumed to be constant.

Its common stock has a book value of \$25 per share, and the firm is in the 40% tax bracket. The following additional data have been gathered for use in analyzing the five capital structures under consideration.

a. Calculate the level of EBIT associated with each of the three levels of sales.

b. Calculate the amount of debt, the amount of equity, and the number of

….

## How much cash will be needed to pay the dividend?

1.“Information asymmetry lies at the heart of the ethical dilemma that managers, stockholders, and bondholders confront when companies initiate management buyouts or swap debt for equity.” Comment on this statement. What steps might a board of directors take to ensure that the company’s actions are ethical with regard to all parties? 2. Stephanie’s Cafes, Inc., has declared a dividend of \$1.30 per share for shareholders of record on Tuesday, May 2. The firm has 200,000 shares outstanding and will pay the dividend on May 24. How much cash will be needed to pay the dividend? When will the stock begin selling ex dividend?