MicroLink Information Technology & Business College

Department of Accounting
Financial Management
Chapter Six

Individual Assignment for Acct Department Second Year Students (5%)

1. GIZACEW Co. manufactures ladies; watch which are sold through discount houses. Each
watch is sold for Br. 25; and fixed costs are Br. 140,000 for 30,000 watches or less; variable
costs are Br. 15 per watch
a. What is the firm’s gain or loss at sales of 8000 watches?
b. What is the company’s degree of operating leverage at sales of 8000 units? Of 1800
units?
c. What is the company’s degree of operating leverage at sales of 8000 units? Of 18000
units?
d. What happens to the breakeven point if the selling price rises to Br. 31? What is the
significance of the change to the financial manager?
e. What happens to the breakeven point of the selling rises to Br. 31 but variable costs rise
to Br. 23 unit?
2. TSEHAY Co., producer of turbine generators; is in this situation: EBIT = Br. 4 million; tax =
T = 35%; debt outstanding = D = Br. 2 million; kd = 10%; ks = 15%; shares of stock
outstanding = No = 600,000; and book value per share = Br. 10. Since the company’s product
market is stable and the company expects no growth, all earnings are paid out as dividends.
The debt consists of perpetual bonds.
a. What are the earnings per share (EPS) and its price per share (Po)?
b. What is the weighted average cost of capital (WACC)?
c. The company can increase debt by Br. 8 million, to a total of Br. 10 million using the
new debt to buy back and retire some of its shares at the current price. Its interest rate on
debt will be 12 percent (it will have to call and refund the old debt), and its cost of equity
 will rise from 15 percent to 17 percent. EBIT will remain constant, should the company
change its capital structure.
d. If the company did not have to refund the Br. 2 million of old debt, how would this affect
thing? Assume that the new and the still outstanding debt are equally risky, with k d =
12%, but that the coupon rates on the old debt is 10 percent.
3. ALEMU Co. produces Building materials which sell for p = Br. 100. Olinde’s fixed costs are
Br. 200,000; 5000 components are produced and sold each year; EBIT is currently Br. 50,000;
and the assets (all equity financed) are Br. 500,000. The company estimates that it can change its
production process, adding Br. 400,000 to investment and Br. 50,000 to fixed operating costs.
This change will
(1) Reduce variable cost per unit by Br. 10 and (2) increase output by 2000 units, but (3) the
sales price on all units will have to be lowered to Br. 95 to permit sales of the additional output.
The company uses no debt and its average cost of capital is 10 percent
a) Should the company make the change
b) Would the company degree of operating leverage increase or decrease if it made
the change? What about its breakeven point?
c) Suppose the company were unable to raise additional, equity financing and had to
borrow the Br. 400,000 to make the investment at an interest rate of 10 percent,
use the DU pont equation to find the expected ROA of the investment. Should the
company make the change if debt financing must be used