SOLUTIONS CHAPTER 4

# SOLUTIONS CHAPTER 4 - CHAPTER 4 LEVERAGE AND RISK ANALYSIS...

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Unformatted text preview: CHAPTER 4 LEVERAGE AND RISK ANALYSIS 4-1 4-2 4-3 (a) All Common Stock All Debt EBIT \$2,400 \$2,400 Less: interest- 600 Earnings before taxes \$2,400 \$1,800 Less: taxes at 50% 1,200 900 Earnings after taxes \$1,200 \$ 900 ÷ Number of common shares ÷ 300 ÷ 200 Earnings per share \$4 .00 \$4 .50 (b) Common Stock Debt BIT = \$1,800 (c) EPS = (\$1,800 - \$0)(1 - 0.5) - \$0 = 3 300 4-4 (a) (b) (c) DCL = DOL x DFL = 4 x 2 = 8 4-5 (a) (b) Sales (\$20 x 1,500) \$30,000 Fixed costs 10,000 Variable costs (\$10 x 1,500) 15,000 Earnings before interest and taxes \$ 5,000 (c) Thus, the break-even point is reduced from 1,000 units to 500 units as a result of the price increase from \$20 to \$30 per unit. Profits are \$10 per unit greater than for each level of sales volume. (d) 4-6 Common Preferred Debt EBIT \$ 125,000 \$ 125,000 \$ 125,000 Interest 6,000 Profit before taxes \$ 125,000 \$125,000 \$ 119,000 Taxes at 48% 60,000 60,000 57,120 Profit after taxes \$ 65,000 \$ 65,000 \$ 61,880 Preferred dividends 7,000 Earnings available to shareholders \$ 65,000 \$ 58,000 \$ 61,880 Shares outstanding ÷ 12,000 ÷ 10,000 ÷ 10,000 EPS \$ 5.41 \$ 5.80 \$ 6.19 The indifference EBIT point is computed as follows: Debt Alternative Stock Alternative EBIT = \$36,000 Preferred Stock Alternative Stock Alternative EBIT = \$80,769 The EPS indifference point is \$36,000 in EBIT for the debt and common stock alternatives: below that level of EBIT the common stock alternative will produce higher EPS and above that level of EBIT the debt alternative will produce higher EPS. The EPS indifference point is \$80,769 in EBIT for the preferred stock and common stock alternative: below that point the common stock alternative will result in higher EPS and above that point the preferred stock alternative will produce higher EPS. If operating profits (EBIT) are indeed \$125,000, the debt alternative is the best option. 4-7 (a) (b) (c) 4-8 (a) Average price per unit = (\$12 + \$8)/2 = \$10 Average variable cost per unit = (\$6 + \$4)/2 = \$5 Weighted average price per unit = \$10.40 Weighted average variable cost per unit = \$5.20 The sales volume for Product A is 9,231 (15,385 x 3/5) units and the sales volume for Project B is 6,154 (15,385 x F 1. Break-even analysis is a device to determine the point at which sales will just cover...
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SOLUTIONS CHAPTER 4 - CHAPTER 4 LEVERAGE AND RISK ANALYSIS...

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