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CHAPTERAND
13 LEVERAGE
Financial risk.
Total risk.
Business risk.
Market risk.
None of the above is correct.
above.)
Business risk
.
Answer: d
Diff: E
Demand variability.
Sales price variability.
The extent to which operating costs are fixed.
Changes in required returns due to financing decisions.
The ability to change prices as costs change.
Business risk
.
Business risk is concerned with the operations of the firm. Which of the
following is not associated with (or not a part of) business risk?
a.
b.
c.
d.
e.
Diff: E
Answer: c
Answer: d
Diff: E
Answer: d
Diff: E
Answer: e
Diff: E
Debt
Debt
Debt
Debt
Debt
=
=
=
=
=
40%;
50%;
60%;
80%;
70%;
Equity
Equity
Equity
Equity
Equity
Diff: E
From the information below, select the optimal capital structure for
Minnow Entertainment Company.
a.
b.
c.
d.
e.
Answer: c
=
=
=
=
=
60%;
50%;
40%;
20%;
30%;
EPS
EPS
EPS
EPS
EPS
=
=
=
=
=
$2.95;
$3.05;
$3.18;
$3.42;
$3.31;
Stock
Stock
Stock
Stock
Stock
price
price
price
price
price
=
=
=
=
=
$26.50.
$28.90.
$31.20.
$30.40.
$30.00.
Answer: e
Diff: E
Chapter 13 - Page 2
Maximum
Minimum
Minimum
Minimum
Minimum
Diff: E
Answer: d
10
Diff: E
Answer: e
Answer: e
Diff: E
Diff: E
a firm
to
Answer: e
Answer: a
Diff: E
Answer: e
Which of the following would increase the likelihood that a company would
increase its debt ratio in its capital structure?
a.
b.
c.
d.
e.
Answer: a
is likely
to encourage
The
The
The
The
The
companys
companys
companys
companys
companys
to
Answer: c
Diff: E
a company
16
Diff: E
Diff: E
Answer: e
Diff: E
Chapter 13 - Page 4
Answer: c
Diff: E
Answer: e
Diff: E
Answer: d
Diff: E
Answer: a
Diff: E
stock price
average cost
stock price
share.
stock price
structure that maximizes the firms times interest earned (TIE) ratio.
d. Statements a and b are correct.
e. Statements b and c are correct.
Capital structure theory
Answer: d Diff: E
21
Answer: c
Diff: E
Answer: a
Diff: E
Chapter 13 - Page 6
Answer: c
Diff: E
Answer: d
Company A and Company B have the same tax rate, the same total assets, and
the same basic earning power. Both companies have a basic earning power
that exceeds their before-tax costs of debt, kd. However, Company A has a
higher debt ratio and higher interest expense than Company B. Which of the
following statements is most correct?
a.
b.
c.
d.
e.
26
Diff: E
Answer: b
Diff: E
Firm U and Firm L each have the same total assets. Both firms also have a
basic earning power of 20 percent. Firm U is 100 percent equity financed,
while Firm L is financed with 50 percent debt and 50 percent equity. Firm
Ls debt has a before-tax cost of 8 percent. Both firms have positive net
income. Which of the following statements is most correct?
a.
b.
c.
d.
e.
Medium:
Optimal capital structure
27
Answer: d
Diff: M
Chapter 13 - Page 8
Answer: e
Diff: M
Answer: c
Diff: M
Company A and Company B have the same total assets, operating income
(EBIT), tax rate, and business risk. Company A, however, has a much higher
debt ratio than Company B. Company As basic earning power (BEP) exceeds
its cost of debt financing (kd).
Which of the following statements is
most correct?
a. Company A has a higher return on assets (ROA) than Company B.
b. Company A has a higher times interest earned (TIE) ratio than Company
B.
c. Company A has a higher return on equity (ROE) than Company B, and its
risk, as measured by the standard deviation of ROE, is also higher than
Company Bs.
d. Statements b and c are correct.
e. All of the statements above are correct.
Limits of leverage
30
Answer: d
Diff: M
Signaling theory
31
Answer: b
Diff: M
If you know that your firm is facing relatively poor prospects but needs
new capital, and you know that investors do not have this information,
signaling theory would predict that you would
a. Issue debt to maintain the returns of equity holders.
b. Issue equity to share the burden of decreased equity returns between
old and new shareholders.
c. Be indifferent between issuing debt and equity.
d. Postpone going into capital markets until your firms prospects
improve.
e. Convey your inside information to investors using the media to
eliminate the information asymmetry.
Answer: d
Diff: M
Answer: b
Diff: M
Chapter 13 - Page 10
Answer: a
Diff: M
Answer: c
Diff: M
Tough:
Variations in capital structures
36
Answer: d
Diff: T
Chapter 13 - Page 12
$2.00
$4.45
$5.00
$5.37
$6.21
Breakeven price
.
Diff: E
The Price Company will produce 55,000 widgets next year. Variable costs
will equal 40 percent of sales, while fixed costs will total $110,000. At
what price must each widget be sold for the company to achieve an EBIT of
$95,000?
a.
b.
c.
d.
e.
38
Answer: e
Answer: a
Diff: E
Texas Products Inc. has a division that makes burlap bags for the citrus
industry.
The division has fixed costs of $10,000 per month, and it
expects to sell 42,000 bags per month. If the variable cost per bag is
$2.00, what price must the division charge in order to break even?
a.
b.
c.
d.
e.
$2.24
$2.47
$2.82
$3.15
$2.00
Medium:
New financing
39
Answer: a
Diff: M
The Altman Company has a debt ratio of 33.33 percent, and it needs to
raise $100,000 to expand.
Management feels that an optimal debt ratio
would be 16.67 percent.
Sales are currently $750,000, and the total
assets turnover is 7.5.
How should the expansion be financed so as to
produce the desired debt ratio?
a.
b.
c.
d.
e.
100% equity
100% debt
20 percent debt, 80 percent equity
40 percent debt, 60 percent equity
50 percent debt, 50 percent equity
5,000
10,000
15,000
20,000
25,000
decks
decks
decks
decks
decks
Diff: M
The Congress Company has identified two methods for producing playing
cards.
One method involves using a machine having a fixed cost of
$10,000 and variable costs of $1.00 per deck of cards. The other method
would use a less expensive machine (fixed cost = $5,000), but it would
require greater variable costs ($1.50 per deck of cards). If the selling
price per deck of cards will be the same under each method, at what level
of output will the two methods produce the same net operating income?
a.
b.
c.
d.
e.
41
Answer: b
Answer: b
Diff: M
Answer: c
Diff: M
$ 183,333
$ 456,500
$ 805,556
$ 910,667
$1,200,000
Chapter 13 - Page 14
Breakeven
43
Answer: d
Elephant Books sells paperback books for $7 each. The variable cost per
book is $5. At current annual sales of 200,000 books, the publisher is
just breaking even. It is estimated that if the authors royalties are
reduced, the variable cost per book will drop by $1.
Assume authors
royalties are reduced and sales remain constant; how much more money can
the publisher put into advertising (a fixed cost) and still break even?
a.
b.
c.
d.
e.
$600,000
$466,667
$333,333
$200,000
$175,225
Operating decision
44
Answer: d
Diff: M
Musgrave Corporation has fixed costs of $46,000 and variable costs that
are 30 percent of the current sales price of $2.15. At a price of $2.15,
Musgrave sells 40,000 units. Musgrave can increase sales by 10,000 units
by cutting its unit price from $2.15 to $1.95, but variable cost per unit
wont change. Should it cut its price?
a.
b.
c.
d.
e.
45
Diff: M
Answer: c
Diff: M
$300,000
$100,000
$ 10,000
40%
Shares outstanding
EPS
Stock price
120,000
$1.45
$17.40
$15.30
$17.75
$18.00
$19.03
$20.48
A consultant
Publishing:
has
collected
Total assets
$3,000
Operating income (EBIT) $800
Interest expense
$0
Net income
$480
Share price
Answer: e
the
following
million
million
million
million
$32.00
information
Diff: M
regarding
Tax rate
Debt ratio
WACC
M/B ratio
EPS = DPS
Young
40%
0%
10%
1.00
$3.20
The company has no growth opportunities (g = 0), so the company pays out
all of its earnings as dividends (EPS = DPS). Youngs stock price can be
calculated by simply dividing earnings per share by the required return on
equity capital, which currently equals the WACC because the company has no
debt.
The consultant believes that the company would be much better off if it
were to change its capital structure to 40 percent debt and 60 percent
equity. After meeting with investment bankers, the consultant concludes
that the company could issue $1,200 million of debt at a before-tax cost
of 7 percent, leaving the company with interest expense of $84 million.
The $1,200 million raised from the debt issue would be used to repurchase
stock at $32 per share. The repurchase will have no effect on the firms
EBIT; however, after the repurchase, the cost of equity will increase to
11 percent. If the firm follows the consultants advice, what will be its
estimated stock price after the capital structure change?
a.
b.
c.
d.
e.
$32.00
$33.48
$31.29
$32.59
$34.72
Tough:
Hamada equation and cost of equity
.
47
Answer: a
Diff: T
14.35%
30.00%
14.72%
15.60%
13.64%
Chapter 13 - Page 16
Answer: d
Diff: T
0.10
0.20
0.30
0.40
0.50
0.90
0.80
0.70
0.60
0.50
Debt-to-equity
ratio (D/E)
0.10/0.90
0.20/0.80
0.30/0.70
0.40/0.60
0.50/0.50
=
=
=
=
=
0.11
0.25
0.43
0.67
1.00
Bond
rating
Before-tax
cost of debt
AA
A
A
BB
B
7.0%
7.2
8.0
8.8
9.6
wc
wc
wc
wc
wc
=
=
=
=
=
0.9;
0.8;
0.7;
0.6;
0.5;
wd
wd
wd
wd
wd
=
=
=
=
=
0.1;
0.2;
0.3;
0.4;
0.5;
WACC
WACC
WACC
WACC
WACC
=
=
=
=
=
14.96%
10.96%
7.83%
10.15%
10.18%
Answer: d
Diff: T
Zippy Pasta Corporation (ZPC) has a constant growth rate of 7 percent. The
company retains 30 percent of its earnings to fund future growth. ZPCs
expected EPS (EPS1) and ks for various capital structures are given below.
What is the optimal capital structure for ZPC?
Debt/Total Assets
20%
30
40
50
70
a.
b.
c.
d.
e.
Debt/Total
Debt/Total
Debt/Total
Debt/Total
Debt/Total
Assets
Assets
Assets
Assets
Assets
=
=
=
=
=
Expected EPS
$2.50
3.00
3.25
3.75
4.00
ks
15.0%
15.5
16.0
17.0
18.0
20%
30%
40%
50%
70%
a.
b.
c.
d.
e.
0% debt; 100%
25% debt; 75%
40% debt; 60%
50% debt; 50%
75% debt; 25%
Dividends
Per Share
$5.50
6.00
6.50
7.00
7.50
Cost of
Equity (ks)
11.5%
12.0
13.0
14.0
15.0
equity
equity
equity
equity
equity
Diff: T
Given the following choices, what is the optimal capital structure for
Chip Co.? (Assume that the companys growth rate is 2 percent.)
Debt Ratio
0%
25
40
50
75
51
Answer: b
Answer: a
Diff: T
$51.14
$53.85
$56.02
$68.97
$76.03
Chapter 13 - Page 18
Answer: a
Diff: T
Etchabarren Electronics has made the following forecast for the upcoming
year based on the companys current capitalization:
Interest expense
Operating income (EBIT)
Earnings per share
$2,000,000
$20,000,000
$3.60
The company has $20 million worth of debt outstanding and all of its debt
yields 10 percent. The companys tax rate is 40 percent. The companys
price earnings (P/E) ratio has traditionally been 12, so the company
forecasts that under the current capitalization its stock price will be
$43.20 at year end.
The companys investment bankers have
recapitalize. Their suggestion is to issue
10 percent to repurchase 1 million shares
the stock can be repurchased at todays $40
Assume that the repurchase will have no effect on the companys operating
income; however, the repurchase will increase the companys dollar
interest expense.
Also, assume that as a result of the increased
financial risk the companys price earnings (P/E) ratio will be 11.5 after
the repurchase. Given these assumptions, what would be the expected yearend stock price if the company proceeded with the recapitalization?
a.
b.
c.
d.
e.
$48.30
$42.56
$44.76
$40.34
$46.90
Answer: d
Diff: T
$106.67
$102.63
$ 77.14
$ 74.67
Chapter 13- Page 19
e. $ 70.40
Capital structure and EPS
54
Answer: d
Buchanan Brothers anticipates that its net income at the end of the year
will be $3.6 million (before any recapitalization). The company currently
has 900,000 shares of common stock outstanding and has no debt.
The
companys stock trades at $40 a share.
The company is considering a
recapitalization, where it will issue $10 million worth of debt at a yield
to maturity of 10 percent and use the proceeds to repurchase common stock.
Assume the stock price remains unchanged by the transaction, and the
companys tax rate is 34 percent. What will be the companys earnings per
share, if it proceeds with the recapitalization?
a.
b.
c.
d.
e.
$2.23
$2.45
$3.26
$4.52
$5.54
Diff: T
Answer: a
Diff: T
A
0.3
10%
B
0.7
14%
The firm will have total assets of $500,000, a tax rate of 40 percent, and
a book value per share of $10, regardless of the capital structure. EBIT
is expected to be $200,000 for the coming year. What is the difference in
earnings per share (EPS) between the two alternatives?
a.
b.
c.
d.
e.
$2.87
$7.62
$4.78
$3.03
$1.19
Answer: d
Diff: T
8.35%
Chapter 13 - Page 20
b. 9.75%
c. 12.27%
d. 10.90%
e. 11.45%
Multiple Part:
(The following information applies to the next four problems.)
Copybold Corporation is a start-up firm considering two alternative capital
structures, one is conservative and the other aggressive. The conservative
capital structure calls for a D/A ratio = 0.25, while the aggressive strategy
calls for D/A = 0.75. Once the firm selects its target capital structure, it
envisions two possible scenarios for its operations: Feast or Famine. The Feast
scenario has a 60 percent probability of occurring and forecasted EBIT in this
state is $60,000. The Famine state has a 40 percent chance of occurring and
expected EBIT is $20,000. Further, if the firm selects the conservative capital
structure its cost of debt will be 10 percent, while with the aggressive capital
structure its debt cost will be 12 percent. The firm will have $400,000 in total
assets, it will face a 40 percent marginal tax rate, and the book value of
equity per share under either scenario is $10.00 per share.
Capital structure and EPS
57
$
0
$1.48
$0.62
$0.98
$2.40
Diff: M
$1.00
$0.80
$2.20
$0.44
$
0
Answer: b
What is the difference between the EPS forecasts for Feast and Famine
under the conservative capital structure?
a.
b.
c.
d.
e.
59
Diff: M
What is the difference between the EPS forecasts for Feast and Famine
under the aggressive capital structure?
a.
b.
c.
d.
e.
58
Answer: e
Answer: c
Diff: M
1.00
1.18
2.45
2.88
3.76
Chapter 13 - Page 22
Answer: a
variation
of
expected
EPS
Diff: M
under
the
0.58
0.39
0.15
0.23
1.00
(The following information applies to the next three problems.)
$5 billion
Total assets
$5 billion
Debt
Common equity
Total debt & common equity
$1 billion
4 billion
$5 billion
The book value of the company (both debt and common equity) equals its market
value (both debt and common equity).
Furthermore, the company has determined
the following information:
The
The
The
The
The
Answer: c
Diff: E
What is Fotopoulos
recapitalization)?
a.
b.
c.
d.
e.
current
Answer: c
unlevered
beta
(before
the
Diff: E
proposed
0.6213
0.8962
0.9565
1.0041
1.2700
Answer: e
Diff: M
What will be the companys new cost of common equity if it proceeds with
the recapitalization? (Hint: Be sure that the beta you use is carried
out to 4 decimal places.)
a.
b.
c.
d.
e.
10.74%
11.62%
12.27%
12.62%
13.03%
(The following information applies to the next two problems.)
An analyst has
Corporation:
collected
the
following
information
regarding
the
Milbrett
Currently, the company has no debt or preferred stock and its interest expense
and preferred dividends equal zero. The book value and market value of common
equity equals $100 million.
The company has 5 million outstanding shares of
common stock, and its stock price is $20 a share.
Milbrett is considering a recapitalization, where they will issue $20 million of
debt and use the proceeds to buy back common stock at the current price of $20 a
share.
As a result of the recapitalization, the size of the firm will not
change.
Assume that the newly-issued debt will have a before-tax cost of
8 percent.
Assume that the recapitalization will have no effect on the
companys basic earning power.
Capital structure, financial leverage, and ratios
64
Diff: E
65
Answer: d
Answer: c
Diff: T
Assume that after the recapitalization the companys times-interestearned ratio will be 12.5.
What is Milbretts expected earnings per
share following the recapitalization?
a.
b.
c.
d.
e.
$2.44
$2.62
$2.76
$2.80
$2.88
Chapter 13 - Page 24
Answer: c
Diff: M
0.43
0.93
1.00
1.06
1.44
Diff: E
67
Answer: c
What would be the companys new cost of common equity (using the CAPM) if
it were to change its capital structure to 40 percent debt and 60 percent
common equity?
(Note:
Here we are asking for the new cost of common
equity, not the WACC!)
a.
b.
c.
d.
e.
11.36%
12.62%
13.40%
14.30%
16.40%
(The following information applies to the next four problems.)
Answer: c
Diff: E
Answer: b
Diff: M
Answer: d
Diff: M
0.4107
0.9583
1.0000
1.0147
1.3800
11.23%
11.71%
12.25%
12.67%
13.00%
Answer: c
Diff: M
$0.75
$2.46
$3.43
$4.04
$6.86
Chapter 13 - Page 26
Answer: c
Diff: E
Medium:
Financial leverage
Answer: e
Diff: M
73
13A- . The use of financial leverage by the firm has a potential impact on
which of the following?
(1)
(2)
(3)
(4)
(5)
a.
b.
c.
d.
e.
The
The
The
The
The
1,
1,
2,
2,
1,
3,
2,
3,
3,
2,
Financial leverage
Answer: d
Diff: M
13A-74. If a firm uses debt financing (Debt ratio = 0.40) and sales change from
the current level, which of the following statements is most correct?
a. The percentage change in net operating income (EBIT) resulting from
the change in sales will exceed the percentage change in net income
(NI).
b. The percentage change in EBIT will equal the percentage change in net
income.
c. The percentage change in net income relative to the percentage change
in sales (and in EBIT) will not depend on the interest rate paid on
the debt.
d. The percentage change in net operating income will be less than the
percentage change in net income.
e. Since debt is used, the degree of operating leverage must be greater
Chapter 13- Page 27
than 1.
Chapter 13 - Page 28
Financial risk
Answer: b
Diff: M
75
Answer: a
Diff: M
Answer: e
Diff: M
DOL
Answer: c
78
operating
leverage
has
which
of
the
Diff: M
following
Answer: a
Diff: M
13A-79. Company D has a 50 percent debt ratio, whereas Company E has no debt
financing. The two companies have the same level of sales, and the same
degree of operating leverage. Which of the following statements is most
correct?
a. If sales increase 10 percent for both companies, then Company D will
have a larger percentage increase in its net income.
b. If sales increase 10 percent for both companies, then Company D will
have a larger percentage increase in its operating income (EBIT).
c. If EBIT increases 10 percent for both companies, then Company Ds net
income will rise by more than 10 percent, while Company Es net
income will rise by less than 10 percent.
d. Answers a and c are correct.
e. None of the answers above is correct.
Degree of leverage
Answer: a
Diff: M
13A-80. Which of the following is a key benefit of using the degree of leverage
concept in financial analysis?
a. It allows decision makers a relatively clear assessment
consequences of alternative actions.
b. It establishes the optimal capital structure for the firm.
c. It shows how a given change in leverage will affect sales.
d. All of the statements above.
e. Only statements a and c above are correct.
Chapter 13 - Page 30
of
the
Answer: a
Diff: E
13A-81. Maxvill Motors has annual sales of $15,000. Its variable costs equal 60
percent of its sales, and its fixed costs equal $1,000.
If the
companys sales increase 10 percent, what will be the percentage
increase in the companys earnings before interest and taxes (EBIT)?
a.
b.
c.
d.
e.
12%
14%
16%
18%
20%
Answer: d
Diff: E
13A-82. Quick Launch Rocket Company, a satellite launching firm, expects its
sales to increase by 50 percent in the coming year as a result of NASA's
recent problems with the space shuttle.
The firm's current EPS is
$3.25. Its degree of operating leverage is 1.6, while its degree of
financial leverage is 2.1.
What is the firm's projected EPS for the
coming year using the DTL approach?
a.
b.
c.
d.
e.
$ 3.25
$ 5.46
$10.92
$ 8.71
$19.63
Change in EPS
Answer: b
Diff: E
13A-83. Your firm's EPS last year was $1.00. You expect sales to increase by 15
percent during the coming year. If your firm has a degree of operating
leverage equal to 1.25 and a degree of financial leverage equal to 3.50,
then what is its expected EPS?
a.
b.
c.
d.
e.
$1.3481
$1.6563
$1.9813
$2.2427
$2.5843
Medium:
DOL change
Answer: a
Diff: M
3.75
4.20
3.50
4.67
3.33
DOL
Answer: d
Diff: M
3.6
4.2
4.7
5.0
5.5
Answer: c
Diff: M
1.0
2.2
3.5
4.0
5.0
Chapter 13 - Page 32
Answer: c
Diff: M
87
1.15
1.00
1.22
1.12
2.68
Answer: d
Diff: M
13A-88. Coats Corp. generates $10,000,000 in sales. Its variable costs equal 85
percent of sales and its fixed costs are $500,000.
Therefore, the
companys operating income (EBIT) equals $1,000,000.
The company
estimates that if its sales were to increase 10 percent, its net income
and EPS would increase 17.5 percent.
What is the companys interest
expense? (Assume that the change in sales would have no effect on the
companys tax rate.)
a.
b.
c.
d.
e.
$100,000
$105,874
$111,584
$142,857
$857,142
DTL
Answer: e
Diff: M
1.714
3.100
3.250
3.500
6.000
Answer: e
Diff: M
90
13A- . Bell Brothers has $3,000,000 in sales. Its fixed costs are estimated to
be $100,000, and its variable costs are equal to fifty cents for every
dollar of sales.
The company has $1,000,000 in debt outstanding at a
before-tax cost of 10 percent. If Bell Brothers' sales were to increase
by 20 percent, how much of a percentage increase would you expect in the
company's net income?
a.
b.
c.
d.
e.
15.66%
18.33%
19.24%
21.50%
23.08%
Expected EBIT
Answer: c
Diff: M
13A-91. Assume that a firm currently has EBIT of $2,000,000, a degree of total
leverage of 7.5, and a degree of financial leverage of 1.875. If sales
decline by 20 percent next year, then what will be the firm's expected
EBIT in one year?
a.
b.
c.
d.
e.
$2,400,000
$1,600,000
$ 400,000
$3,600,000
$1,350,000
Expected EBIT
Answer: d
Diff: M
92
13A- . Assume that a firm has a degree of financial leverage of 1.25. If sales
increase by 20 percent, the firm will experience a 60 percent increase
in EPS, and it will have an EBIT of $100,000. What will be the EBIT for
this firm if sales do not increase?
a.
b.
c.
d.
e.
$113,412
$100,000
$ 84,375
$ 67,568
$ 42,115
Expected EBIT
Answer: e
Diff: M
$ 60,000
$175,000
$100,000
$ 90,000
$114,000
Chapter 13 - Page 34
Answer: d
Diff: M
94
13A- . A company currently sells 75,000 units annually. At this sales level,
its EBIT is $4 million, and its degree of total leverage is 2.0. The
firm's debt consists of $15 million in bonds with a 9.5 percent coupon.
The company is considering a new production method which will entail an
increase in fixed costs but a decrease in variable costs, and will
result in a degree of operating leverage of 1.6. The president, who is
concerned about the stand-alone risk of the firm, wants to keep the
degree of total leverage at 2.0. If EBIT remains at $4 million, what
amount of bonds must be retired to accomplish this?
a.
b.
c.
d.
e.
$8.42
$9.19
$7.63
$6.58
$4.44
million
million
million
million
million
Tough:
Financial leverage, DOL, and DTL
Answer: a
Diff: T
13A-95. A company has an EBIT of $4 million, and its degree of total leverage is
2.4. The firms debt consists of $20 million in bonds with a 10 percent
yield to maturity. The company is considering a new production process
that will require an increase in fixed costs but a decrease in variable
costs. If adopted, the new process will result in a degree of operating
leverage of 1.4.
The president wants to keep the degree of total
leverage at 2.4. If EBIT remains at $4 million, what amount of bonds
must be outstanding to accomplish this (assuming the yield to maturity
remains at 10 percent)?
a.
b.
c.
d.
e.
$16.7
$18.5
$19.2
$19.8
$20.1
million
million
million
million
million
Answer: c
Diff: T
13A-96. Lincoln Lodging Inc. estimates that if its sales increase 10 percent
then its net income will increase 18 percent. The companys EBIT equals
$2.4 million, and its interest expense is $400,000.
The companys
operating costs include fixed and variable costs. What is the level of
the companys fixed operating costs?
a.
b.
c.
d.
e.
$ 450,000
$ 666,667
$1,200,000
$2,000,000
$2,125,000
ANSWERS
AND SOLUTIONS
CHAPTER
13
1.
Business risk
Answer: c
Diff: E
2.
Business risk
Answer: d
Diff: E
3.
Business risk
Answer: d
Diff: E
Answer: d
Diff: E
5.
Answer: e
Diff: E
6
.
The optimal capital structure maximizes the firms stock price and minimizes
the firms WACC.
Optimal capital structure
Answer: c
Diff: E
7.
Answer: e
Diff: E
8.
Answer: e
Diff: E
9.
Answer: d
Diff: E
10Both an increase in the corporate tax rate and a decrease in the companys
degree of operating leverage will encourage the firm to use more debt in its
capital structure. Therefore, the correct choice is statement d.
.
Answer: e
Diff: E
Statement e is the correct choice. Lowering the corporate tax rate reduces the
tax advantages of debt leading firms to use less debt financing.
If the
personal tax rate were to increase, individuals would now find interest
received on corporate debt less attractive, causing firms to utilize less debt
financing. An increase in the costs of bankruptcy would lead firms to use less
debt in order to reduce the probability of having to incur these higher costs.
11.
Answer: e
Diff: E
12.
Statement e is correct. Less stable sales would lead a firm to reduce its debt
ratio.
A lower corporate tax rate reduces the tax advantage of the
deductibility of interest expense. This reduction in the tax shield provided
by debt would encourage less use of debt. If management believes the firms
stock is overvalued, then it would want to issue equity rather than debt,
thereby increasing the firms equity ratio.
Leverage and capital structure
Answer: a Diff: E
Statement a is correct; all the other statements are false. Since interest is
tax deductible, it would make sense to increase debt if the corporate tax rate
rises.
Interest received by individual investors is not tax exempt, so an
increase in the personal tax rate would not encourage a firm to increase its
debt level in the capital structure. Increasing operating leverage would
discourage a company from increasing debt. If a companys assets become less
liquid, it would hurt the companys financial position, making it less likely
that the firm could make interest payments when necessary. An increase in
Answer: e
Diff: E
If the costs incurred when filing for bankruptcy increased, firms would be
penalized more if they filed for bankruptcy and would be less willing to take
that risk. Therefore, they would reduce debt levels to help avoid bankruptcy
risk, so statement a is false.
An increase in the corporate tax rate would
mean that firms would get larger tax breaks for interest payments. Therefore,
firms have an incentive to increase interest payments, in order to reduce
taxes.
Therefore, they will increase their debt ratios, so statement b is
true. An increase in the personal tax rate decreases the after-tax return that
investors will receive. Firms will have to issue debt at higher interest rates
in order to provide investors with the same after-tax returns they used to
receive.
This will raise firms costs of debt, which will increase their
WACCs, so firms will not increase their debt ratios. Therefore, statement c is
false. If a firms business risk decreases, then this will tend to increase
its debt ratio. Therefore, statement d is true. Since both statements b and d
are true, the correct choice is statement e.
14.
Answer: a
Diff: E
15.
Answer: c
Diff: E
The correct answer is statement c. The company will have higher debt interest
payments, so net income will decline. Thus, statement a is false. The effect
on EPS is ambiguous. Earnings decline (NI), but so will the number of shares.
Therefore, statement b is false. The firms recapitalization will not change
total assets.
However, since net income declines, ROA will decrease; so
statement d is false. As long as the BEP ratio is greater than the cost of
debt, ROE will increase. However, you dont have enough information to
determine the cost of debt, so you can make no determination about ROE. Thus,
statement e is false.
The increase in debt will increase the risk to
shareholders, so the cost of equity will increase. Therefore, statement c is
correct.
16.
Answer: e
Diff: E
debt will likely lead to an increase in the WACC. But this is not true across
all levels of debt. [Think of a firm with no debt: increasing the debt ratio
to just 10% will probably lower the WACC]. This also explains why statement c
is incorrect. A firm with a high debt ratio (i.e., 90%) will likely increase
its WACC by further increasing its debt. Statement b is incorrect. Although
EPS is maximized, the total value of the company may be compromised.
This
contrasts with statement d. The capital structure that maximizes stock price
should minimize the WACC. So, statement d is also incorrect.
17.
Answer: c
Diff: E
k
WACC
D/A ratio
18.
Statement a is false. The WACC does not necessarily increase. Remember, you
are replacing high cost equity with low cost debt. When there is very little
debt in the capital structure, the WACC will actually decrease.
(See the
diagram above.)
The capital structure that maximizes stock price is not
necessarily the capital structure that maximizes EPS, so statement b is false.
If the corporate tax rate increases, companies will obtain a bigger tax
advantage for their interest payments.
Thus, they may increase their debt
levels to take advantage of this situation, and this would raise debt ratios.
Therefore, the correct answer is statement c.
Capital structure and WACC
Answer: e Diff: E
Statement a is false; if you are to the left of the firms optimal capital
structure on the WACC curve, increasing a companys debt ratio will actually
decrease the firms WACC. Statement b is false; if you are to the right of the
firms optimal capital structure on the WACC curve, increasing a companys debt
ratio will actually increase the firms WACC.
Statement c is false; as you
increase the firms debt ratio the cost of debt will increase because youre
using more debt. Because youre using more debt the cost of equity also
increases because the firms financial risk has increased. From statements a
and b you can see that whether the WACC is increased depends on where you are
on the WACC curve relative to the firms optimal capital structure. Therefore,
the correct answer is statement e.
19.
20
.
Answer: d
Diff: E
Answer: a
Diff: E
Statement a is correct; the other statements are false. The capital structure
that maximizes the firms stock price generally calls for a debt ratio that is
lower than the one that maximizes EPS.
The firm could maximize its TIE by
having no debt (that is zero interest payments). But, this capital structure
would probably not maximize the firms stock price.
21.
Answer: d
Diff: E
Answer: c
Diff: E
Financial
leverage
and
Answer: a Diff: E
EPS
Statement a is true; a higher EPS does not always mean that the stock price
will increase.
Statement b is false; a lower WACC will mean a higher stock
price. Statement c is false; EPS can increase just because shares outstanding
decline.
(The firms net income will decline because its interest expense
increases.)
24.
Answer: c
Diff: E
Statement a is false because BEP = EBIT/Total assets. The extent to which the
firm uses debt financing does not affect EBIT or total assets. Statement b is
false because firms with a high percentage of fixed costs have a high degree of
operating leverage by definition.
25.
Answer: d
Diff: E
BEP = EBIT/TA. Since they both have the same total assets and the same BEP,
then EBIT must be the same for both companies. If A has a higher debt ratio
and higher interest expense than B, and they both have the same EBIT and tax
rate, then A must have a lower NI than B. Therefore, statement a is true. If
A has a lower NI than B but both have the same total assets, then As ROA
(NI/TA) must be lower than Bs ROA. Therefore, statement b is true. If both
companies have the same total assets but As debt ratio is higher than Bs,
then As equity must be lower (since Total assets = Total debt + Total equity).
If A has less equity, and a lower NI than B, it is not possible to judge which
companys ROE (NI/EQ) is higher.
26.
Answer: b
Diff: E
BEP = EBIT/TA. If both firms have the same BEP ratio and same total assets,
then they must have the same EBIT. Since Firm U has no debt in its capital
structure, Firm U will have higher net income than Firm L because U has no
interest expense and L does. The TIE ratio is EBIT/Int. If the two companies
have the same EBIT, the one with the lower interest expense (Firm U), will have
a higher TIE. Therefore, statement a is false. Firms L and U have the same
EBIT, but Firm L has a higher interest expense, so its net income will be lower
than Firm U. Since ROA is equal to NI/TA, and the two firms have the same total
assets, Firm L will have a lower ROA than Firm U. Therefore, statement b is
true. Leverage will increase ROE if BEP > kd. Since BEP is 20 percent and kd
is 8 percent, leverage will increase Firm Ls ROE. Therefore, statement c is
false.
27.
Answer: d
Diff: M
28.
Answer: e
Diff: M
29.
Answer: c
Diff: M
30.
31.
Signaling theory
Answer: b
Diff: M
32.
Answer: d
Diff: M
Answer: b
Diff: M
35
.
36
.
37.
Answer: a
Diff: M
Statement a is true; the other statements are false. If the personal tax rate
were increased, investors would prefer to receive less of their income as
interest--implying firms would substitute equity for debt. High business risk
is associated with high operating leverage; therefore, firms with high business
risk would use less debt.
Miscellaneous capital structure concepts
Answer: c
Diff: M
If corporate tax rates were decreased while other things were held constant,
and if the MM tax-adjusted tradeoff theory of capital structure were correct,
corporations would decrease their use of debt because the tax shelter benefit
would not be as great as when tax rates are high.
Business risk is the
riskiness of the firms operations if it uses no debt.
The optimal capital
structure does not maximize EPS, and the degree of total leverage shows how a
given change in sales will affect earnings per share.
Variations in capital structures
Answer: d
Diff: T
Answer: e
Diff: E
38
.
39
EBIT
$95,000
$205,000
$205,000
P
=
=
=
=
=
PQ - VQ - FC
P(55,000) - (0.4)P(55,000) - $110,000
(0.6)(55,000)P
33,000P
$6.21.
Breakeven price
Answer: a
Diff: E
Answer: a
Diff: M
New financing
Old debt ratio = 0.3333; New debt ratio = 0.1667.
Sales
= 7.5.
TA
$750,000
TA =
= $100,000.
7.5
Debt = 0.3333($100,000) = $33,333.
New TA = $100,000 + $100,000 = $200,000.
New Debt = $200,000(0.1667) = $33,333.
40
.
Answer: b
Diff: M
Answer: b
Diff: M
41
.
solve for Q:
$1.50(Q) + $5,000
$0.5(Q)
Q.
Calculate the old and new breakeven volumes using the old data
projections:
Old QBE = $120,000/($1.20 - $0.60) = $120,000/$0.60 = 200,000 units.
New QBE = $240,000/($1.05 - $0.41) = $240,000/$0.64 = 375,000 units.
Change in breakeven volume = 375,000 - 200,000 = 175,000 units.
42.
FC
$400,000
FC
VC/unit =
$4.20
VC =
111$7.00
Price/unit
Sales
Answer: c
and
Diff: M
new
$400,000
= $1,000,000.
1 - 0.60
$650,000
$650,000
$4.48 =
=
= $1,805,556.
11 - 0.64
$7.00
Breakeven
Answer: d
Diff: M
$7(200,000) - $5(200,000) - F = 0
F = $400,000.
$7(200,000) - $4(200,000) - F = 0
F = $600,000.
$600,000 - $400,000 = $200,000.
44
.
Operating decision
Answer:
Diff: M
45
.
Diff: M
We can do this problem by using the P/E before and after the recapitalization.
Recall that P/E = Price/EPS.
EBIT
Interest
EBT
Tax (40%)
NI
Shares
EPS
P/E
Before recap.
$300,000
-10,000
$290,000
116,000
$174,000
120,000
$174,000/120,000 = $1.45.
$17.40/1.45 = 12.
After recap.
$300,000
-50,000
$250,000
100,000
$150,000
100,000*
$150,000/100,000 = $1.50.
46.
47.
Answer: e
Diff: M
Step 1:
Step 2:
Step 3:
Step 4:
Answer: a
Diff: T
Step 1:
Step 2:
Find the
b =
1.2 =
1.2 =
1.0435 =
Step 3:
Find the new levered beta given the new capital structure using the
Hamada equation:
b = bU[1 + (1 - T)(D/E)]
b = 1.0435[1 + (0.6)(1)]
b = 1.6696.
Step 4:
Find
ks =
ks =
ks =
the firms new cost of equity given its new beta and the CAPM:
kRF + RPM(b)
6% + 5%(1.6696)
14.35%.
48.
Answer: d
Diff: T
kRF = 5%; kM - kRF = 6%; ks = kRF + (kM - kRF)b; WACC = wdkd(1 - T) + wcks.
You need to use the D/E ratio given for each capital structure to find the
levered beta using the Hamada equation. Then, use each of these betas with the
CAPM to find the ks for that capital structure. Use this k s and kd for each
capital structure to find the WACC. The optimal capital structure is the one
that minimizes the WACC.
(D/E) b = bU[1 + (1 - T)(D/E)]
0.11
0.25
0.43
0.67
1.00
1.0667
1.1500
1.2571
1.4000
1.6000
11.4000%
11.9000
12.5429
13.4000
14.6000
wc
kd
0.9
0.8
0.7
0.6
0.5
7.0%
7.2
8.0
8.8
9.6
wd
WACC
0.1
0.2
0.3
0.4
0.5
10.68%
10.38
10.22
10.15
10.18
50
.
Answer: d
Diff: T
The optimal capital structure maximizes the firms stock price. When the debt
ratio is 20%, expected EPS is $2.50. Given the firms policy of retaining 30%
of earnings, the expected dividend per share D1 is $2.50 0.70 = $1.75. The
stock price P0 is $1.75/(15% - 7%) or $21.88. When the debt ratio is 30%,
expected EPS is $3.00 and expected D1 is $3.00 0.70 = $2.10. The stock price
P0 is $2.10/(15.5% - 7%) = $24.71. Similarly, when the debt ratio is 40%, D 1 =
$2.275 and P0 = $25.28.
When the debt ratio is 50%, D 1 = $2.625 and P0 =
$26.25.
When the debt ratio is 70%, D 1 = $2.80 and P0 = $25.45.
The stock
price is highest when the debt ratio is 50%.
Capital structure and stock price
Answer: b
Diff: T
First, calculate the stock price for each debt level using the dividend growth
model, P0 = D1/(kS - g):
Debt
0%
25
40
50
75
Div/share
$5.50
6.00
6.50
7.00
7.50
kS
11.5%
12.0
13.0
14.0
15.0
P0
$5.50/(0.115 - 0.02)
$6.00/(0.12 - 0.02)
$6.50/(0.13 - 0.02)
$7.00/(0.14 - 0.02)
$7.50/(0.15 - 0.02)
=
=
=
=
=
$57.89.
$60.00.
$59.09.
$58.33.
$57.69.
Clearly, $60.00 is the highest price, so 25% debt and 75% equity is the optimal
capital structure.
51.
Answer: a
Diff: T
First, find the companys current cost of capital, dividends per share,
stock price:
ks = 0.066 + (0.06)0.9 = 12%.
To find the stock price, you still need
dividends per share or DPS = ($2,000,000(1 - 0.4))/200,000 = $6.00. Thus,
stock price is P0 = $6.00/0.12 = $50.00. Thus, by issuing $2,000,000 in
debt the company can repurchase $2,000,000/$50.00 = 40,000 shares.
and
the
the
new
Now after recapitalization, the new cost of capital, DPS, and stock price can
be found:
ks = 0.066 + (0.06)1.1 = 13.20%. DPS for the remaining (200,000 - 40,000) = 160,000
shares are thus [($2,000,000 - ($2,000,000 0.10))(1 - 0.4)]/ 160,000 = $6.75.
And, finally, P0 = $6.75/0.132 = $51.14.
52.
Answer: a
Diff: T
$20,000,000
6,000,000
$14,000,000
5,600,000
$ 8,400,000
P/E = 11.5.
P0 = ($4.20)(11.5) = $48.30.
Answer: d
Diff: T
The bonds used in the repurchase will create a new interest expense for the
company. This will change net income. Dividends per share will change because net
income changes and the number of shares outstanding changes.
54.
Diff: T
After issuing the debt, the company can repurchase $10,000,000/$40 = 250,000
shares leaving 650,000 shares outstanding. We still need to find the expected
Answer: a
Diff: T
Capital structure A: The firm will have debt of $500,000(0.3) = $150,000 and
equity of $350,000.
Were told the shares have a book value of $10 so the
number of shares outstanding is $350,000/$10 = 35,000. Interest expense will
be $150,000(10%) = $15,000.
We can compute EBT as EBIT - I or $200,000 $15,000 = $185,000. Also, we can compute NI as EBT(1 - T) or $185,000(1 - 0.4)
= $111,000. Finally, EPS = $111,000/35,000 = $3.17.
Capital structure B: The firm will have debt of $500,000(0.7) = $350,000 and
equity of $150,000. The number of shares outstanding is $150,000/$10 = 15,000.
Interest expense will be $350,000(14%) = $49,000.
We can compute EBT as
$200,000 - $49,000 = $151,000. Also, we can compute NI as $151,000(1 - 0.4) =
$90,600. Finally, EPS = $90,600/15,000 = $6.04.
The difference in EPS between capital structure A and capital structure B is
$6.04 - $3.17 = $2.87.
56.
Answer: d
Diff: T
You need to find the beta with no debt and the new k s with the new capital
structure before you can calculate the firms WACC.
Step 1:
Step 2:
Calculate the firms new beta with the new capital structure:
bL = bU[1 + (1 - T)(D/E)]
bL = 0.954545[1 + (0.6)($5/$5)]
bL = 1.5273.
Step 3:
new
cost
of
with
the
new
capital
Step 4:
57.
equity
Answer: e
Diff: M
Debt = 75% = $300,000; Equity = 25% = $100,000; BVPS = $10; Total assets =
$400,000.
Probability
EBIT
Less: Interest
Feast
0.6
$60,000
36,000
Famine
0.4
$20,000
36,000
EBT
Less: Taxes (40%)
NI
# shares
EPS
58
.
$24,000
9,600
$14,400
10,000
$1.44
($16,000)
(6,400)
($ 9,600)
10,000
-$0.96
Answer: b
Diff: M
Debt = 25% = $100,000; Equity = 75% = $300,000; BVPS = $10; Total assets =
$400,000.
Probability
EBIT
Less: Interest
EBT
Less: Taxes (40%)
NI
# shares
EPS
59
.
Feast
0.6
$60,000
10,000
$50,000
20,000
$30,000
30,000
$1.00
Famine
0.4
$20,000
10,000
$10,000
4,000
$ 6,000
30,000
$0.20
Answer: c
Diff: M
Answer: a
Diff: M
Answer: c
Diff: E
First, we will calculate the cost of common equity and then use that to solve
for the WACC.
ks = kRF + (kM - kRF)b
ks = 5% + (6%)1.1
ks = 11.6%.
WACC = wdkd(1 - T) + wcks
WACC = (0.2)(7.5%)(1 - 0.4) + (0.8)(11.6%)
WACC = 10.18%.
62.
Answer: c
Diff: E
To unlever the beta, we must use the Hamada equation, substituting the known
values.
bL
1.1
1.1
bU
63.
=
=
=
=
bU[1 + (1 - T)(D/E)]
bU[1 + (1 - 0.4)(1/4)]
bU[1.15]
0.9565.
Answer: e
Diff: M
First, we must find the levered beta after the recapitalization, using the
unlevered beta calculated in the previous problem.
bL
bL
bL
bL
=
=
=
=
bU[1 + (1 - T)(D/E)]
0.9565[1 + (1 - 0.4)(2/3)]
0.9565[1.4]
1.3391.
64.
Answer: d
Diff: E
Answer: c
Diff: T
Step 2:
Determine the firms interest expense, given the TIE and EBIT:
EBIT
Interest
$20,000,000
12.5 =
Interest
12.5Interest = $20,000,000
$1,600,000 = Interest.
TIE =
Step 3:
Step 4:
Step 5:
66
net income:
$20,000,000
1,600,000
$18,400,000
7,360,000
$11,040,000
Hamada
equation
and
Answer: c
bL =
1.2=
1.2=
bU =
67
unlevered
Diff: E
beta
N
bU[1 + (1 - T)(D/E)]
bU[1 + (0.60)(0.25/0.75)]
bU[1.2]
1.00.
Hamada
equation
and
cost
of
Answer: c
common
Diff: M
equity
N
68.
Step 1:
Calculate the new levered beta using the Hamada equation and the
unlevered beta calculated previously:
bL = bU[1 + (1 - T)(D/E)]
bL = 1.00[1 + (0.60)(0.40/0.60)]
bL = 1.40.
Step 2:
Calculate the new cost of equity using the CAPM equation and the new
levered beta:
ks = 5% + (6%)1.40 = 13.40%.
Answer: c
Diff: E
9.2625% 9.26%.
69.
Answer: b
Diff: M
Answer: d
Diff: M
=
=
=
=
bU[1 + (1 - T)(D/E)]
bU[1 + (0.6)(0.25/0.75)]
bU[1.2]
bU.
Calculate the new levered beta for the firm, using the new capital
structure:
bU = 0.9583; New D = 50%; New E = 50%; T = 40%.
bL = bU[1 + (1 - T)(D/E)]
= 0.9583[1 + (0.60)(0.50/0.50)]
= 1.5333.
Step 2:
71.
Calculate
follows:
net
EBIT
Interest
EBT
Taxes (40%)
NI
Step 2:
income
under
$300,000
200,000
$100,000
40,000
$ 60,000
Answer: c
the
firms
new
Diff: M
capital
structure
as
(given)
(given)
Answer: c
Diff: E
Answer: e
Diff: M
Answer: d
Diff: M
Answer: b
Diff: M
Answer: a
Diff: M
Answer: e
Diff: M
7813-. DOL
Answer: c
Diff: M
Answer: a
Diff: M
Answer: a
Diff: M
Answer: a
Diff: E
= $5,000.
Now, assuming sales increase by 10% or to $15,000 1.10 = $16,500, calculate the
new EBIT. EBIT = $16,500 - ($16,500 0.60) - $1,000 = $5,600.
So, the percentage increase is [($5,600 - $5,000)/$5,000] 100 = 12%.
8213-. DTL and forecast EPS
EPS1 =
=
=
=
Answer: d
Diff: E
Answer: b
Diff: E
Answer: a
Diff: M
EPS1 = ?
= EPS0[1.0 + (DTL)(%Sales)]
= $1.00[1.0 + (4.375)(0.15)]
= $1.00(1.6563) = $1.6563.
8413-. DOL change
Calculate DOL using new sales, new variable cost percentage, and new fixed
costs:
S0 = $75,000,000; FC0 = $40,000,000; VC = 0.30(S0) = $22,500,000.
S1 = $100,000,000; FC1 = $55,000,000; VC = 0.25(S1) = $25,000,000.
DOL (In millions):
DOLS =
100 - 25
75
=
= 3.75.
100 - 25 - 55
20
8513-. DOL
Answer: d
Diff: M
Answer: c
Diff: M
Use the information provided and the formula for DOL in sales dollars:
DOLS =
150,000($4) - 0.3(150,000)($4)
150,000($4) - 0.3(150,000)($4) - 0.5(150,000)($4)
DOLS =
$600,000 $180,000
$600,000 $180,000 $300,000
$420,000
= 3.5.
$120,000
DOLS =
Alternate method:
Express P as 1.0 or 100% of price and V and FC as a percent of price:
Q(P V)
150,000(1.0 - 0.3)
0.7
=
=
= 3.50.
150,000[(1.0 - 0.3) - 0.5]
0.2
Q(P V) FC
DOLQ =
Answer: c
Diff: M
First, calculate PQR's DFL as EBIT/(EBIT - I). Interest expense (I) on the
debt is $1,500,000(10%) = $150,000.
We can work backwards from NI to find
EBIT as follows: EBT = NI/(1 - T) or $600,000/0.6 = $1,000,000. EBIT = EBT +
I or $1,000,000 + $150,000 = $1,150,000. DFL is thus $1,150,000/($1,150,000 $150,000) = 1.15. Recognizing DTL = DFL DOL, we can solve 1.40 = 1.15 DOL
for DOL = 1.22.
8813-. DTL and interest expense
Answer: d
Diff: M
Answer: e
Diff: M
Answer: e
Diff: M
S VC
S VC FC I
$10,000,000 $8,500,000
$10,000,000 $8,500,000 $500,000 I
$1,500,000
$1,000,000 I
$1,750,000 - 1.75I
$142,857.14 $142,857.
8913-. DTL
DTL = (S - VC)/(EBIT - I)
= ($3,000,000 - $1,800,000)/($700,000 - $500,000)
= 6.
9013-. DTL and change in NI
Step 1:
S V
S V F I
$3,000,000 - 0.5($3,000,000)
$3,000,000 - 0.5($3,000,000) - $100,000 - 0.1($1,000,000)
$1,500,000
$1,300,000
= 1.1538.
=
Step 2:
Answer: c
Diff: M
DOL = DTL/DFL
= 7.5/1.875 = 4.0.
EBIT = (-0.20)(4.0)($2,000,000) = -$1,600,000.
EBIT = $2,000,000 - $1,600,000 = $400,000.
Answer: d
Diff: M
Answer: e
Diff: M
X 60,000
X 60,000
60,000
DOLQ = 2.5 =
=
60,000
170,000 - 125,000
0.36
125,000
X 60,000
60,000
X 60,000
0.90 =
60,000
$54,000 = X - $60,000
X = $114,000.
2.5(0.36) =
Answer: d
Diff: M
1.25 =
$4,000,000
$4,000,000 - I
$800,000
= $8,421,053.
0.095
Answer: a
Diff: T
for the new debt level, knowing that the yield to maturity
= Interest payment
= $1,666,686.11
= $16,666,861.11 $16.7 million.
Answer: c
Diff: T
% EBIT
% EPS
% Sales
% EBIT
% EPS
% Sales
18%
=
10%
DTL = 1.8.
DFL = $2,400,000/($2,400,000 - $400,000)
= 1.2.
Given DTL = DFL DOL, we can calculate DOL = 1.5. Recognizing S - VC - FC =
EBIT, 1.5 = (S - VC)/$2,400,000 or S - VC = $3,600,000. The difference between
(S - VC) and EBIT must represent fixed operating costs. Thus, FC = $3,600,000
- $2,400,000 = $1,200,000.