The Fat-bat Company is considering produce and sell high quality stereo speakers.

The sales price would

be set at 1.5 times the variable cost per unit; the variable cost per unit is estimated to be P75.00; and
fixed costs are estimated at P1,200,000.

1. What sales volume would be required to break even, i.e. to have EBIT = 0?
- CM = Sales – Total VC
- CM = (75 x 1.5) – 75
- CM = 37.5
- BEP = 1.2M/37.5
- BEP = 32,000
2. What if the Fat-Bat sold 40,000 units of stereo, how much will be the net income?
- Net Income = CM – TFC
- (37.50 x 40,000) – 1.2M
- 1.5M – 1.2M
- 300,000

PROBLEM A: Captain Barbie Company has the following forecast for 2018: Forecast sales in units 50,000
Selling price per unit P100 Variable cost per unit P70 Fixed costs: Manufacturing overhead and expenses
P300,000 Interest expense P40,000 EPS P8.50 TAX 40%

1. What is the amount of income after tax?

- Sales (50,000 x 100) = 5M
- VC (50,000 x 70) = 3.5M
- Contribution Margin (5M – 3.5M) = 1.5M
- EBIT (1.5M – 300,000) = 1.2M
- EBT (1.2M – 40,000) = 1.160M
- NET INCOME AFTER TAX (1.160M – 464,000) = 696,000
2. Compute the breakeven point in number of units
- CMU = 1.5M/50,000 = 30
- BEP = 340,000/30 = 11,333
3. At sales level of 40,000 units, what is the degree of operating leverage?
- Sales (40,000 x 100) = 4M
- VC (40,000 x 70) = 2.8M
- Contribution Margin (4M – 2.8M) = 1.2M
- EBIT (1.2M – 300,000) = 900,000
- EBT (900,000 – 50,000) = 850,000
- NET INCOME AFTER TAX (850,000 – 340,000) = 510,000
- DOL = CM/EBIT
- DOL = 1.2M/900,000 = 1.33
PROBLEM A: Captain Barbie Company has the following forecast for 2018: Forecast sales in units 40,000
Selling price per unit P100 Variable cost per unit P70 Fixed costs: Manufacturing overhead and expenses
P300,000 Interest expense P50,000 EPS P8.50 TAX 40%

1. At sales level of 40,000 units, what is the degree of financial leverage?

- Sales (40,000 x 100) = 4M
- VC (40,000 x 70) = 2.8M
- Contribution Margin (4M – 2.8M) = 1.2M
- EBIT (1.2M – 300,000) = 900,000
- EBT (900,000 – 50,000) = 850,000
- NET INCOME AFTER TAX (850,000 – 340,000) = 510,000
- DFL = EBIT/EBT = 900,000/850,000 = 1.06

PROBLEM B: A firm has EBIT of P3.6M and debt of P15M on which it pays 8% interest. What is its degree
of financial leverage (DFL)?

- DFL = 3.6M/ (3.6M – 15M (8%))

- DFL = 3.6M/ 3.6M – 1.2M = 1.5

PROBLEM A: Captain Barbie Company has the following forecast for 2018: Forecast sales in units 40,000
Selling price per unit P100 Variable cost per unit P70 Fixed costs: Manufacturing overhead and expenses
P300,000 Interest expense P50,000 EPS P8.50 TAX 40%

1. At sales level of 40,000 units, what is the degree of combined leverage?

- DCL = CM/EBT
- DCL = 1.2M/850,000 = 1.41

Shares Co. is trying to estimate its optimal capital structure. Right now, Shares has a capital structure
that consists of 40 percent debt and 60 percent equity (its D/E ratio is 0.667.). The riskfree rate is 6
percent and the market risk premium, rm – rf, is 5 percent. Currently the company’s cost of equity,
which is based on the CAPM, is 14 percent and its tax rate is 40 percent.

1. What would be Echo’s estimated cost of equity if it were to change its capital structure to 50
percent debt and 50 percent equity?
- Cost of equity = 15.14%