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.
Find break even in units and in sales