Old Exam Questions - Capital Structure and Leverage - Solutions
Page 31 of 59 Pages
C.
$225,000
D.
$300,000
*
E.
$250,000
Interest = ($1,500,000)*(.10) = $150,000
Price per unit = $3.50
Variable Cost per Unit = ($3.50)*(.60) = $2.10
DTL = [(P-V)Q] / [(P-V)Q - F - I]
1.40 = [($3.50 - $2.10)*(1,000,000)] / ($3.50 - $2.10)*(1,000,000) - Fixed - $150,000
1.40 = $1,400,000 / ($1,400,000 - Fixed - $150,000)
1.40 = $1,400,000 / ($1,250,000 - Fixed)
Fixed = ($1,750,000 - $1,400,000) / 1.40 = $250,000
Proof:
Sales
$3,500,000
Variable Costs
- $2,100,000
Fixed Costs
- $ 250,000
EBIT
$1,150,000
Interest
- $ 150,000
EBT
$1,000,000
Taxes
- $ 400,000
Net Income
$ 600,000
33.
Assume that Firm A is an unlevered firm with total assets of $1,000. The probability
distribution for its earnings over the coming year is given in the table below. The firm
is thinking about issuing $500 of debt (it will use the proceeds to repurchase their own
equity) to increase its expected return on equity. However, whether or not a firm’s use
of debt can increase the expected return on equity is a factor of the firm’s cost of debt
or the amount of interest that they pay. Given the information above and below,
determine the maximum dollar interest the firm can pay before it begins to decrease
the expected return on equity.
Economy
Firm A: Unlevered
Bad
Average
Good
Probability
20%
50%
30%
EBIT
$100.00
$150.00
$220.00
Interest
$0.00
$0.00
$0.00
EBT
$100.00
$150.00
$220.00
Taxes (40%)
-$40.00
-$60.00
-$88.00