Answer to the Question P13-1:

Given That,
Fixed operating Cost, FC= $12,350 per year
Variable cost, VC= $15,45 per arrangement
Sale price. P=$ 24.95 per arrangement
Total number of flower arrangement, Q=?

We Know,
FC
Q=
(P-VC)
$12,350
Q=
($24.95-15.45)
Q= 1300
(Ans)

Answer to the Question P13-2:

Firm F G H

Sales Price per Unit, P $18.00 $21.00 $30.00

$6.75 $13.50 $12.00

Variable operating cost per unit, VC
Fixed Operting Cost,FC 45000 30000 90000

We Know,
FC
Q=
(P-VC)
For Firm F,
45000
Q=
$(18.00-6.75)
Q= 4000
For Firm G,
30000
Q=
$(21.00-13.50)
Q= 4000
For Firm H,
90,000
Q=
$(30.00-12.00)
Q= 5000

b. From least risky to most risky: F and G are of equal risk, then H. It is important to
recognize that operating leverage is only one measure of risk.
Answer to the Question P 13-3:

a) Given That,
Fixed operating Cost per Year, FC= $473,000
Variable cost per product, VC= $86.00
Sale price per product. P= $129.00

We Know,
FC
Q=
(P-VC)
so, Firm's operating breakdown points
473000
Q=
$(129.00-86.00)
Q= 11000 units
b)
Answer to the Question P 13-4:

a)
Fixed operating Cost per Year, FC= $73,500
Variable cost per CD, VC= $10.48
Sale price per CD. P= $13.98
Operating Breakdown point (no of CD),Q= ?
We Know,
FC
Q=
(P-VC)
$73,500
Q=
$(13.98-10.48)
Q= 21000 CD's

b) Total operating costs= FC+(Q x VC)

Total operating costs= $(73500 + (21000 X 10.48))
Total operating costs= $293,580

c) Minimum sales per month 2, 000

Minimum sales per year = 2000 X12
Minimum sales per year (no's) = 24,000
Difference between Minimun sale and break even point= (24000-21000)
= 3000
As Minimun sale exceeds the operating breakeven by 3,000 records per year.
Barry should go into the CD business

d)

calculating EBIT for the minimum sale of 2000 CD per month

EBIT= ($13.98 X 24,000) - $73,500 - ($10.48 X 24,000)

EBIT= $335,520 - $73,500 - $251,520
EBIT= $10,500
Answer to the Question P 13-9:

a) Sales Price per Unit, P $63.50

Variable cost per unit, VC $16.00
Fixed Operting Cost,FC $380,000

We Know,
FC
Q=
(P-VC)
$380,000
Q=
$(63.50-16.00)
Q= 8000 units
b)
Units
Descriptions 9000 10000 11000

63.50*9000 63.50*10000 63.50*11000

Sales ( $ 63.50 per unit)
$571,500.00 $635,000.00 $698,500.00
Less: variable cost ($ 16 per unit) $144,000 $160,000.00 $176,000.00
$427,500.00 $475,000.00 $522,500.00
Less:Fixed cost $380,000 $380,000 $380,000
EBIT $47,500 $95,000 $142,500

C) Change in unit sales (As

10000 unit base) -1000 0 1000

% change in sales (As -0.1 0 0.1

10000 unit )
-10% ### 0% ### 10%
Change in EBIT (As 10000 unit EBIT ($47,500) $0 $47,500
=$95000)

% Change in EBIT (As -50% 0 50%

10000 unit EBIT =$95000)

d) % Change in EBIT -50%

= = 5
% change in sales -10%

e) Now Calculating Degree of operating leverage

[10,000 X ($63.50 -$16.00)]

DOL=
[10,000 X ($63.50 - $16.00)- $380,000]
=5
Answer to the Question P 13-10:

a)
Sales Price per Unit, P = $9.75
Variable operating cost per unit, VC = $6.75
Fixed Operting Cost,FC = $72,000

We Know,
FC
Q=
(P-VC)
$72,000
Q=
$(9.75-6.75)
Q= 24000
b) Now Calculating Degree of operating leverage

For 25000 Unit , Degree of operating leverage

DOL= [25,000 X ($9.75 -$6.75)]

[25,000 X ($9.75 - $6.75)- $72,000]
= 25

For 30,000 Unit , Degree of operating leverage

DOL= [30,000 X ($9.75 -$6.75)]

[30,000 X ($9.75 - $6.75)- $72,000]
=5

For 40,000 Unit , Degree of operating leverage

[40,000 X ($9.75 -$6.75)]
DOL=
[40,000 X ($9.75 - $6.75)- $72,000]
DOL= 2.5
c)
d) For 24,000 Unit , Degree of operating leverage

[24,000 X ($9.75 -$6.75)] 72000

DOL= =
[24,000 X ($9.75 - $6.75)- $72,000] 0
=∞
At the operating breakeven point (24,000 units), the DOL is infinite

e) DOL decreases as the firm expands beyond the operating breakeven point

Answer to the Question P 13-12:

a) Given That
Loan Interest,( I) 250, 000 of 16% = $40,000
common Stock 2000 shares
Taxes 40% 0.4

Descriptions a ### b
EBIT $80,000 $120,000
Less Interest $40,000 $40,000
Net profits before taxes $40,000 $80,000.00
Less: Taxes (40%) (Net profit X Tax) $16,000.00 $16,000.00
Net profit after taxes $24,000 $64,000
divided by EPS (2,000 shares) (24000/2000) (64000/2000)
EPS $12 $32

b) Degree of Financial Leverage,DFL

Preferred stock dividends =PD

Preferred stock dividends =PD =0

$80,000
DFL =
$(80000-40000-0)
DFL = 2

C ) Now calculating $100,000 of 16% (annual interest)

Loan Interest,( I)100, 000 of 16% = $16,000

common Stock = 3000 shares

Descriptions a ### b
EBIT $80,000 $120,000
Less Interest $16,000 $16,000
Net profits before taxes $64,000 $104,000.00
Less: Taxes (40%) (Net profit X Tax) $25,600.00 $41,600.00
Net profit after taxes $38,400 $62,400
divided by EPS (3,000 shares) (38400/3000) (62400/3000)
EPS $12.80 ### $20.80

$80,000
DFL =
$(80000-16000-0)
$80,000
DFL =
$64,000
= 1.25

Answer to the Question P 13-15:

 Given That
Sales Price per Unit, P = $1.00
Variable cost per unit, VC = $0.84
Fixed Operting Cost,FC = $28,000
tax (40%) = 0.4
Annual interest, I = $6,000
Preferred dividends, PD $2,000
Total selling quantity, Q = 400000
a) $28,000
Calculating Break operating point , Qb = = 175,000 units
$(1.00-0.84)
b) now,

[400000 X ($1.00 -$0.84)]

DOL=
[400000 X ($1.00 - $0.84)- $28,000]
64000
DOL=
36000
DOL= 1.78
c) Now for calculating EBIT

EBIT= [($1.00 X 400000)-28000-($0.84 X 400000)]

EBIT= $400,000 - $28,000 - $336,000
$36,000

$36,000
DFL =
[$(36000-6000- 2000 X( 1/(1-0.4 ))]
$36,000
DFL =
26667
DFL = 1.35
d) Now Calculating Degree of total leverage

(400000 X ($1.00- $0.84)

DTL=
(400000 X ($1.00- $0.84)- $28000-$6000- (2000-(1-0.4)))
DTL= 2.4
DTL= DFL X DOL= 1.78 X 1.35
DTL= 2.4
The two formulas give the same result (verified)

Answer to the Question P 13-17:

a) Sales Price per latch, P = $6.00
Variable cost per latch, VC = $3.50
Fixed Operting Cost,FC = $50,000
Annual Interest, I $13,000
Preferred Divided, PD $7,000
Calculating Break operating point of $50,000
=
Carolina Fastner , Qb $(6.00-$3.50)
Calculating Break operating point of = 20000 latches
Carolina Fastner , Qb
b) Total sales unit,Q 30000
.
Description Unit
Total Sales ( S=(Q X P) $180,000.00
(-) Less: variable cost (VC X Q) $105,000
(-)Less Fixed cost , FC $50,000.00
EBIT (S- VCx Q- FC) $25,000
(-) Less Interest, I $13,000
EBT (EBIT-I) $12,000
(-) Less Tax @40% ( EBT X Tax) $4,800.0
Net Profit $7,200.0

C now,

[30000 X ($6.00 -$3.5)]

DOL=
[[30000 X ($6.00 -$3.5)]- $28,000]
75000
DOL=
25000
DOL= 3
d) Now

$25,000
DFL =
[$(25000-13000- (7000 X( 1/(1-0.4 ))]
$25,000
DFL =
333.33
K
DFL = 75
e) DTL= DFL X DOL
DTL= = 3 X 75
DTL= 225
DTL= 22500%

f
15000
Change in sales =
30000
 = 50%
Percentage change in EBIT = % change in sales X DOL
= 50% X 3
= 150%

New EBIT = $25,000 + ($25,000 X 150%)

EBIT = $62,500

Percentage change in earnings available for common = % change sales X DTL

Percentage change in earnings available for common = 50%X 225

Percentage change in earnings available for common = 11250%

New earnings available for common= $200 + ($200 X 11,250%)

New earnings available for common = $$22,700,064
a
 Answer to the Question P9-5

Given That
Alternative
A B C D
number of years to the bond’s maturity, n = 16 5 7 10
net proceeds from the sale of debt (bond,) Nd = $1,220 $1,020 $970 $895
Annual interest in dollars, I =
(coupon rate X value per share)
9% X $1000 7% X $1000 6% X $1000 5% X $1000
Annual interest in dollars, I =
$90 $70 $60 $50
Tax @40% = $0.4 $0.4 $0.4 $0.4
We know that for calculating before-tax cost, rd

For Alternative A

$90 + $1000 - $1220

rd = 16
$1220 +$1000
2
rd = $76.25
$1,110
rd = 6.87%
after-tax cost of debt, ri,

ri = 6.87 % X (1 - 0.4)
ri = 4.12%
For Interest, I=6.71%
ri = 6.71% X (1 - 0.4) = 4.03%
For Alternative B
$1000 - $1020
$70 +
5
rd =
$1020 +$1000
2
rd = $66.00
$1,010
rd = 6.54%
after-tax cost of debt, ri,

ri = 6.54 % X (1 - 0.4)
ri = 3.92%
For Interest, I=6.52%
ri = 6.52% X (1 - 0.4) = 3.91%
For Alternative C
$1000 - $970
$60 +
7
rd =
$970 +$1000
2
rd = $64.29
$985
rd = 6.53%
after-tax cost of debt, ri,

ri = 6.53 % X (1 - 0.4)
ri = 3.92%
For Interest, I=6.55%
ri = 6.52% X (1 - 0.4) = 3.93%

For Alternative D
$1000 - $895
$50 +
10
rd =
$895 +$1000
2
rd = $60.50
$947
rd = 6.39%
after-tax cost of debt, ri,

ri = 6.39 % X (1 - 0.4)
ri = 3.83%
For Interest, I=6.46%
ri = 6.46% X (1 - 0.4) = 3.87%
 Answer to the question no- 9.7

a) Dp
the cost of preferred stock, rp, =
Np
$12
the cost of preferred stock, rp, =
$95
the cost of preferred stock, rp, = 0.1263
12.63%
b)
annual dollar divident, Dp= 100 X10%
annual dollar divident, Dp= 10
net proceeds from the sale of the stock, Np = $90

Dp
the cost of preferred stock, rp, =
Np
the cost of preferred stock, rp, = (10/90)
the cost of preferred stock, rp, = 0.1111
the cost of preferred stock, rp, = 11.11%

Answer to the question no- 9.9

Given That,
beta, b = 1.2
risk-free rate , Rf = 6%
Market return, rm = 11%
We know that calculating required rated of return, rs

rs = 6%+ [1.2 X (11%-6%)]

rs = 6%+6%
 rs = 12%
a) Risk premium, Rf = 6%
b) Rate of return, rs = 12%
c) After-tax cost of common equity 12%
using the CAPM = rs

Answer to the question no- 9.13

a) Types of capital Book Value weight cost weighted cost

L-T debt $700,000 0.5 5.30% 2.650%
(+) preferred stock $50,000 0.036 12.00% 0.432%
(+) Common stock $650,000 0.464 16.00% 7.424%
$1,400,000 1 10.506%

The WACC is the rate of return that the firm must receive on long-term projects to maintain the value of
b) the firm. The cost of capital can be compared to the .return for a project to determine whether the
project is acceptable

Answer to the question no- 9.14

a) Book Value weights

Types of capital Book Value weight After tax cost weighted cost
L-T debt $4,000,000 0.784 6.00% 4.706%
(+) preferred stock $40,000 0.008 13.00% 0.102%
(+) Common stock $1,060,000 0.208 17.00% 3.533%
$5,100,000 8.341%

b) Market Value weights

Types of capital Book Value weight cost weighted cost
L-T debt $3,840,000 0.557 6.00% 3.342%
(+) preferred stock $60,000 0.009 13.00% 0.117%
(+) Common stock $3,000,000 0.435 17.00% 7.395%
$6,900,000 10.854%

c) The difference lies in the two different value bases. The market value approach yields the better value
since the costs of the components of the capital structure are calculated using the prevailing market
prices. Since the common stock is selling at a higher value than its book value, the cost of capital is
much higher when using the market value weights. Notice that the book value weights give the firm a
much greater leverage position than when the market value weights are used.
 Answer to the question no- 9.15

a) Historical market weights:

Types of capital weight cost weighted cost
L-T debt 0.250 7.20% 1.800%
(+) preferred stock 0.100 13.50% 1.350%
(+) Common stock 0.650 16.00% 10.400%
13.550%

b) Targetl market weights:

Types of capital weight cost weighted cost
L-T debt 0.300 7.20% 2.160%
(+) preferred stock 0.150 13.50% 2.025%
(+) Common stock 0.550 16.00% 8.800%
12.985%

c) Using the historical weights the firm has a higher cost of capital due to the weighting of the more
expensive common stock component (0.65) versus the target weight of (0.55). This over-weighting in
common stock leads to a smaller proportion of financing coming from the significantly less expensive
long-term debt and the lower-costing preferred stock.
 Answer to the question no- 9.10

we know that
Cost of common stock equity:

Given that
n(2012-2008)= 4
Initial value (PV) = $2.12
Future value (FVn) $3.10
current price $57.5
net proceeds per share $52
divident (2013) $3.4
a) Now solve for growth rate, r

Now

calutaing , r
3.1= 2.1 X (1+r)^4
now, r = 9.97%

b) Net proceeds vale (Np)= $52 given

C) Next divident
cost of retained earnings, rr. = + growth rate
current price
$3.40
cost of retained earnings, rr. = + 9.97%
57.5
cost of retained earnings, rr. = $0.06 + 0.097
cost of retained earnings, rr. = $0.1561
cost of retained earnings, rr. = 15.61%

d) Next divident
cost of new common stock, rn = + growth rate
net proceeds
$3.40
cost of new common stock, rn = + 9.97%
52
cost of new common stock, rn = $0.07 + 0.097
cost of new common stock, rn = $0.1624
cost of new common stock, rn = 16.24%
 Answer to the question no- 9.11

net precceds
Projected (Nn) (Nn=
Current market price per Divident growth divident per underpricing Floating cost cuurent price-
Firm share (Po) rate (g) share next yr next yr per share floating cost-
(D1) underpricing
next yr)
net precceds (Nn)= curent market price-floating cost- underpricing next yr
A $50.00 8% 2.25 $2.00 $1.00 50-2-1 $47.00
B 20 4 1 0.5 1.5 20-0.5-1.5 $18.00
C 42.5 6 2 1 2 42.5-1-2 $39.50
D 19 2 2.1 1.3 1.7 19-1.3-1.7 $16.00

We know that

D1 D1=Projected divident per share next yr

cost of retained earnings, rr. = + g
Po g=Divident growth rate
Po- current market price
D1 Nn= net preceds value
cost of rcommon stock, rn. = + g
Nn
For Firm A
$2.25
cost of retained earnings, rr. = + 8.00%
$50.00
cost of retained earnings, rr. = 12.50%

$2.25
cost of new common stock, rn = + 8.00%
47
cost of new common stock, rn = 12.79%

For Firm B
$1.00
cost of retained earnings, rr. = + 4.00%
$20.00
cost of retained earnings, rr. = 9.00%

$1.00
cost of new common stock, rn = + 4.00%
18
cost of new common stock, rn = 9.56%

For Firm C
$2.00
cost of retained earnings, rr. = + 6.00%
$42.50
cost of retained earnings, rr. = 10.71%
$2.00
cost of new common stock, rn = + 6.00%
39.5
cost of new common stock, rn = 11.06%

For Firm D
$2.10
cost of retained earnings, rr. = + 2.00%
$19.00
cost of retained earnings, rr. = 13.05%
$2.10
cost of new common stock, rn = + 2.00%
16
cost of new common stock, rn = 15.13%