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L8-ch15-HO-sol-1-3 - 1 Emma Corporation has $1,500,000 debt...

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1. Emma Corporation has $1,500,000 debt with 12% interest and has $480,000 preferred equity with 15% annual dividend. The company was able to sell 50,000 units of its product at $80 per unit in the current year. Contribution margin ratio = CM/SALES is 30% and all costs of goods sold are variable. In addition, if company’s sale changes by 1% from its current level, its EPS will change by 4%. (Company is in 40% tax bracket). 4 = DOL*DFL DOL=CM/[CM – F] = 1,200,000/[1,200,000- 600,000] a. If the firm’s current fixed operating cost is $600,000, what are the firm degree of operating leverage and financial leverage? DOL = 2 DFL = 2 THIS YEAR Q BE =F/[P-V] = 600,000/[80-56] = 25,000 NEXT YEAR Q BE =F/[P-V] 25,000 = F/[80- 44.8] NEW F = 880,000 NEXT YEAR V = 56 - 0.20*56 = 44.8 b. How much addition could the firm make to its fixed operating cost if it can reduce its variable cost per unit by 20% and wants to keep the break- even point in units unchanged from the current one? 880,000 – 600,000 = 280,000 2. Use the following information to answer the given questions: Current assets = $50,000 Fixed asset turnover = 4 times Total variable costs = CGS Operation profit margin = 20% of sales Interest = $10,000 per year # of units sold = 5,000 units Selling price per unit = $100 Fixed operating cost = $30,000 Company uses only debt and common equity # of common stock = 1,000 shares Q BE =F/[P-V] = 30,000/[100-74] = SALES BE = Q BE *100 = a.
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