Financial leverage differences between an Automotive company vs.

a utility company

Market Conditions

Utility Company does not worry about changes in economy.

Utility company can have more debt, because a lot of their income is guarranteed

Automotive company can struggle during a downturn in the economy,

and has to worry about debt
Discuss the limitations of Financial Leverage

*When companies borrow money, they have to sign on to Debt Covenants (Promises on what the company can do)
Creditors enforce conditions on the use of funds, on whether or not the company can have more debt.

While debt is cheap

he company can do)
SUS Toasters

Selling Price $20.00

Variable cost $15.00
Contribution Margin $5.00

Annual Fixed Cost $80,000.00

A) How many toasters to Break Even

16000 Fixed Cost / Contribution Margin per unit

B)
Sales $320,000.00 16K units @ $20/Unit
Variable Cost $240,000.00
Contriution Margin $80,000.00
Fixed Cost $80,000.00
Operating Profit $0.00
Harding Company
They Sell Skates
A) Degree of Operation Leverage
Price 50 CM/EBIT
Quantity 10,000 2 2X
Variable Cost 20
B) Degree of Financial Leverage
Sales 500000 EBIT/EBT
Variable Cost 200000 1.666667 1.67X
Contribution Margin 300000
Fixed Cost 150,000
EBIT 150,000 C) Degree of Total Leverage
Interest Expense 60,000 3.333333 3.33X
EBT 90,000
Tax Rate @ 40% 36000
Net Income 54,000 D) Break even point in Skates
30 Contribution Margin Per unit
5000 Skates
e) Break even point including Interest Expese
30 Contribution Margin per unit
7000 Skates
Mo's Delicious Burgers
Selling Price 15
Cost 10
Fixed Cost 80,000
Contribution margin 5
Units Sold
A) What is the breakeven in box 15000
16000 Boxes 20000
30000
Units Sold 15000 20000 30000 40000 40000
Sales $225,000.00 $300,000.00 $450,000.00 $600,000.00
Variable Cost $150,000.00 $200,000.00 $300,000.00 $400,000.00
Contribution Margin $75,000.00 $100,000.00 $150,000.00 $200,000.00
Fixed Cost $80,000.00 $80,000.00 $80,000.00 $80,000.00
Operating Profit -$5,000.00 $20,000.00 $70,000.00 $120,000.00
Profit per unit -$0.33 $1.00 $2.33 $3.00
Operating Profit per unit
-$0.33
$1.00
$2.33
$3.00
 Cain Able Cain Scenerio 1Scenerio 2
Market Value Debt 50,000 100,000 EBIT $10,000 $15,000
Market Value Equity 100,000 50,000 Interest 5000 5000
Common Shares Outstanding 10,000 5,000 EBT $5,000 $10,000
Taxes @ 30% $1,500 $3,000
D/E 0.5 2 Net Income $3,500 $7,000
EPS $0.35 $0.70

Able Scenerio 1Scenerio 2

EBIT $10,000 $15,000
Interest 10000 10000
EBT $0 $5,000
Taxes @ 30% $0 $1,500
Net Income $0 $3,500
EPS $0 $0.70
Scenerio 3
$50,000
5000
$45,000
$13,500
$31,500
$3.15

Scenerio 3
$50,000
10000
$40,000
$12,000
$28,000
$5.60