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Unformatted text preview: CHAPTER 12 ANSWERS 12-1 Accounts payable, accrued wages, and accrued taxes increase spontaneously and proportionately with sales. Retained earnings increase, but not proportionately. 12-2 a. + b.- The firm needs less manufacturing facilities, raw materials, and work in process. c. + It reduces spontaneous funds; however, it may eventually increase retained earnings. d. + e. + f. + This should stimulate sales, so it might be offset in part by increased profits. g. h. + 12-3 Breakeven analysis, whether operating or financial, shows: (a) profit planning in relationship to its main determinants. (b) the effects of leverage on profitability. (c) the effects of changes in volume on profitability. In addition, operating breakeven analysis helps in deciding the desired proportion of fixed costs to variable costs, and financial breakeven analysis helps in determining whether to finance the firm with securities that have fixed obligations (debt and preferred stock) or common stock. Some of the problems with operating breakeven analysis are that it assumes linear cost and revenue curves that might be unrealistic, and it cannot handle changes in the level of fixed costs. Financial breakeven analysis suffers from the same problemsthat is, it is assumes interest payments are fixed rather than variable. 12-4 Operating leverage is the presence of fixed costs in the operation of a firm. Operating profits fluctuate when sales increase or decrease. Because only the variable costs change with sales volume changes, the operating profits of a firm with a high percentage of fixed costs are magnified when sales increasecosts increase only by the low percentage of variable costs, not by the relative change in sales. 12-5 Financial leverage exists when there exists fixed financing costs. The amount of earnings that can be distributed to common shareholders varies when operating income (EBIT) changes. Because only the amount of taxes paid changes with increases or decreases in EBIT, changes in the earnings that can be distributed to common stockholders will be magnified if the firm has a high degree of financial leveragetaxes increase by the same proportion and the financing costs do not change by the relative change in EBIT. 211 12-6 The selling price per unit, the variable cost per unit, and total fixed costs are necessary to construct an operating breakeven chart. The procedure also can be accomplished by using total sales dollars, total fixed costs, and total cost per unit. 12-7 Such financial charges as interest and preferred stock dividends and the tax rate are needed to construct a financial breakeven chart. 12-8 The operating and financial breakeven points will be affected as follows: Operating Financial Breakeven Breakeven a. An increase in the sales price- b. A reduction in variable labor costs- c. A decrease in fixed operating costs- d. Issuing new bonds + e. Issuing new preferred stock + f. Issuing new common stock Note that those actions that affect the firms production function have an impact on the...
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