Chapter 16
Capital Structure Decisions: The Basics
SOLUTIONS TO END-OF-CHAPTER ODD NUMBERED PROBLEMS
16-1
a.
Here are the steps involved:
(1)
Determine the variable cost per unit at present, V:
Profit
= P(Q) - FC - V(Q)
$500,000
= ($100,000)(50) - $2,000,000 - V(50)
50(V)
= $2,500,000
V
= $50,000.
(2)
Determine the new profit level if the change is made:
New profit
= P
2
(Q
2
) - FC
2
- V
2
(Q
2
)
= $95,000(70) - $2,500,000 - ($50,000 - $10,000)(70)
= $1,350,000.
(3)
Determine the incremental profit:
Profit = $1,350,000 - $500,000 = $850,000.
(4)
Estimate the approximate rate of return on new investment:
ROI = Profit/Investment = $850,000/$4,000,000 = 21.25%.
Since the ROI exceeds the 15 percent cost of capital, this analysis suggests that the
firm should go ahead with the change.
Mini Case:
16 - 1