6-1

WELCOME TO
Problems on
CHAPTER 11:
Capital Structure &
Leverage
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6-2

Self-test Problems (page 294): SP 1, 2, 9 & 11

SP-1: Suggested solution
(a)

I NCOME ...................
F IXED COSTS ............
V ARIABLE COSTS .......
T OTAL COSTS ...........
G AIN (L OSS ) ............
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125,000 UNITS
R S .1,875,000
700,000
1,250,000
R S .1,950,000
(R S .75,000)

175,000 UNITS
R S .2,625,000
700,000
1,750,000
R S .2,450,000
R S .175,000
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6-3

SP-1: (b)

F
(R S .700,000)
(R S .700,000)
B )Q* =
=
=
=
140,000
P V R S .15 R S .10
R S .5
UNITS

S* = Q P = (140,000)(R S .15) = R S .2,100,000

(Chart is not given here.)
SP-1: (c) First, prepare partial income

statements for 125,000 units, 150,000 units,

175,000 units, and for some increase over
175,000 units, say 185,000 units.
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NOI = (P V)Q
F
125,000
R S .625,000
R S .75,000
150,000
750,000
50,000
175,000
875,000
175,000
185,000
925,000
225,000
Percentage change in operating income
DOL =
Percentage change in units sold
U NITS

(P V)Q

6-4

[(50,000 (-75,000)]/-75,000
DOL125,000 =------------------------------------ = -8.3
(150,000-125,000)/125,000
If company is operating at a level of 125,000 units, a 1
percent increase in quantity sold will produce an 8.3
percent
decrease in profits.
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6-5

(175,000-50,000)/50,000
DOL150,000 = --------------------------------------- = 15x
(175,000 150,000)/150,000
If the firm is operating at ........... units, a 1%
increase in quantity sold will produce ........?%
increase in profits.
(225,000-175,000)/175,000
DOL175,000 = --------------------------------------- = 5x
(185,000 175,000)/175,000
If the firm is operating at ........... units, a 1%
increase in quantity sold will produce ........?%
increase in profits.

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6-6

SP-2: (a)

Particular
Income
Fixed costs
Variable costs
Total costs
Gain (loss)

5,000 units
Rs.225,000
175,000
100,000
Rs.275,000
(Rs. 50,000)

12,000 units
Rs.540,000
175,000
240,000
Rs.415,000
Rs.125,000

(b) Fixed costs

175,000
Q* =------------------ = ----------------- = 7,000 units
P-V
45-20
S* = 7000 x Rs.45 = Rs.315,000
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6-7

(c) Cash BEP

Fixed costs - Dep 175,000-110,000 65,000
Q* =-------------------------- = ---------------------- =--------P-V
45-20
25
= 2600 units
S* = 2600 x Rs.45 = Rs.117,000
(d) 4,000 (Rs.45 - Rs.20) = Rs.100,000. It is short
of covering all fixed charges, i.e., 110,000. But
it can cover more than cash fixed charges of
Rs.65,000. The margin is wide.
Creditors need not seek liquidation. At the
most they may be advised to accept late
payments.
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6-8

SP-9:
MSC: P=$2, V=$1.3, F=$20,000, 4000 shares.
CSC: Same except 2000 shares, Rs.2500
interest.
Tax = 50%, Sales $80,000 i.e., $80,000/$2
= 40,000 units.
(a) DOL=?
S-V
80,000 (40,000*1.3)
DOL =--------- = ----------------------------------- =3.5
S-V-F 80,000-52,000-20,000
If sales increase by 10%, operating profit will
increase by 35%. DOL is the same for both firms.
(b) DFL=?
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6-9

(b) DFL=?
MSC
CSC
Sales
$80,000
$80,000
Less variable costs@$1.3 52,000
52,000
28,000
28,000
Less fixed costs
20,000
20,000
EBIT
8,000
8,000
Less interest
0
2,500
EBT
8,000
5,500
DFL = EBIT/(EBIT-I)
MSC: 8000/(8000-0) = 1.0x
10% increase in EBIT means 10% increase in
EPS.
CSC: 8000/(8000-2500) = 1.45x
10% increase in EBIT means 14.5% increase in
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EPS.

(c) DTL=?

6 - 10

MSC:
S-V
80,000 52,000
DTL MSC=------------ = ----------------------------------S-V-F-I 80,000-52,000-20,000-0

=28000/8000 = 3.5
10% increase in sales leads to 10x3.5 =35%
increase in earnings available to common stock
holders, or EPS.
CSC:
S-V
80,000 52,000
DTL CSC=------------ = ----------------------------------S-V-F-I 80,000-52,000-20,000-2500
=28000/5500 = 5.0
10% increase in sales leads to 10x5 =50%
increase in earnings available to common stock
holders, or EPS.
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SP-11:
Present financial structure:
Bonds @6%
Common 100,000 shares @ $50

6 - 11

$8,000,000
$5,000,000

Plans to raise $4,000,000

3 plans:
Plan A: 100% common at $50
Plan B: 50% bonds @8%
Plan C: 100% bonds @ 10%
Tax= 50%

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6 - 12

Plan A:100% common stock

EBIT could be $1m or $2m.
EBIT
$1000,000
Less interest
480,000
EBT
520,000
Less tax @50%
260,000
Earn. avail. to Common260,000
No. of old shares
100,000
New shares $4m/$50
80,000
Total shares
180,000
EPS
$1.44
Copyright by R.S.Pradhan

$2000,000
480,000
1520,000
760,000
760,000
100,000
80,000
180,000
$4.22
All rights reserved.

Plan B: 50% bonds at 8%

50% bonds
Bond
2,000,000
Common
2,000,000
Total
4,000,000
EBIT
Less old interest
Less new interest
EBT
Less tax
Earnings avail. To CS holders
No. of shares
Old
New
Total
EPS

Copyright by R.S.Pradhan

6 - 13

1,000,000
480,000
160,000
360,000
180,000
180,000
100,000
40,000
140,000
1.285714286

2,000,000
480,000
160,000
1,360,000
680,000
680,000
100,000
40,000
140,000
4.8571429

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6 - 14

Plan C: 100% bonds: $4m at 10% interest

100% bonds at
Bond
12,000,000
Common
5,000,000
Total
17,000,000
EBIT
Less old interest
Less new interest
EBT
Less tax
Earnings avail. To CS holders
No. of shares
Old
New
Total
EPS
Copyright by R.S.Pradhan

1,000,000 2,000,000
480,000
480,000
400,000
400,000
120,000 1,120,000
60,000
560,000
60,000
560,000
100,000
100,000
100,000
100,000
0.6
5.6
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Chart:
Plan A
Datum points EPS 1.44
Fixed charge
480,000
:
100% debt Plan C

6Plan
- 15 C
Plan B
1.29
0.60
640,000 880,000
50% debt Plan B

EPS
100% Common Plan A
4

Indiff pt A & B
1.2 million

3
2
1

Indiff pt B & C =
Indiff pt A & C =
0.5

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For EBIT of $1 million

1.5

1.48 million
1.38 million
EBIT
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Indifference point between Plans A & B: 6 - 16

EBIT* - FA
EBIT* - FB
------------ =
------------n
n

EBIT* 480,000
=
EBIT* 640,000
180,000
140,000
180,000 EBIT* - (180,000 x 640,000) = 140,000 EBIT* -(140,000 x 480,000)
40,000 EBIT* (115,200)
=
(67,200)
40,000 EBIT*
=
(67,200) +
40,000 EBIT*
=
48,000
EBIT*
=
1.2 million
Copyright by R.S.Pradhan

115,200

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6 - 17

Indifference point between Plans A & C:

EBIT* - FA
EBIT* - FC
------------ =
------------n
n
EBIT* 480,000
=
EBIT* 880,000
180,000
100,000
180,000 EBIT* - (180,000 x 640,000) = 140,000 EBIT* -(140,000 x 480,000)
80,000 EBIT* (158,400)
=
(48,000)
80,000 EBIT*
=
(48,000) +
80,000 EBIT*
=
110,400
EBIT*
=
1.38 million

Copyright by R.S.Pradhan

158,400

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Indifference point between Plans B & C:

EBIT* - FB
EBIT* - FC
------------ =
------------n
n

6 - 18

EBIT* 640,000
=
EBIT* 880,000
140,000
100,000
180,000 EBIT* - (180,000 x 640,000) = 140,000 EBIT* -(140,000 x 480,000)
40,000
EBIT* (123,200)
=
(64,000)
40,000 EBIT*
=
(64,000) +
40,000 EBIT*
=
59,200
EBIT*
=
1.48 million

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123,200

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6 - 19

1. Quiz
2. Case:
Presentation date: ???
Group report be submitted first.
Each member must give the presentation.

Thanking you

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