# Ans Doc 116

10) McFrugal, Inc. has expected sales of \$20 million. Fixed operating costs are \$2.5 million, and the variable cost ratio is 65 percent. Mcfrugal has outstanding a \$12 million, 8 percent bank loan. The firm also has outstanding 1 million shares of common stock (\$1 par value). McFrugal’s tax rate is 40 percent.

a. What is McFrugal’s degree of operating leverage at a sales level of \$20 million?
12) East Publishing Company is doing an analysis of a proposed new
finance textbook. Using the following data, answer (a) through (d).

Fixed Cost per Edition:

Development (reviews, class testing , and so on) \$18,000
Copyediting 5,000
Selling and promotion 7,000
Typesetting 40,000
Total \$70,000

Variable Cost per Copy:
Printing and binding \$4.20
Salespeople’s commission (2% of selling price) 0.60
Author’s royalties (12% of selling price) 3.60
Bookstore discounts (20% of selling price) 6.00
Total \$16.00

Projected Selling Price \$30.00

The company’s marginal tax rate is 40 percent.

a. Determine the company’s breakeven volume for this book:

b. Develop a breakeven chart for the textbook.
II. In dollar sales
c. Determine the number of copies East must sell in order to earn an (operating) profit of \$21,000 on this book.
d. Suppose East feels that \$30.00 is too high a price to charge for a new finance textbook. It has examined the competitive market and determined that \$24.00 would be a better selling price. What would the breakeven volume be at this new selling point?
15) Rodney Rogers, a recent business school graduate, plans to open a wholesale dairy products firm. The business will be completely financed with equity. Rogers expects first year sales to total \$5,500,000. He desires to earn a target pretax profit of \$1,000,000 during his first year of operation. Variable costs are 40 percent of sales.

a. How large can Rogers’ fixed operating costs be if he is to meet his profit target?
b. What is Rogers’ breakeven level of sales at the level of fixed operating costs determined in (a)?
6) What is the underlining objective of EBIT-EPS analysis?
8) In practice what are the factors managers consider in setting a firm’s target capital structure?
4) Emco Products has a present capital structure consisting only of common stock (10 million shares). The company is planning a major expansion. At this time, the company is undecided between the following two financial plans (assume a 40 percent marginal tax rate):

Plan 1 (Equity financing). Under this plan, an additional 5 million shares of common stock will be sold at \$10 each.

Plan 2 (Debt financing). Under this plan, \$50 million of 10 percent long term debt will be sold.

One piece of information the company desires for its decision analysis is an EBIT-EPS analysis.

a. Calculate the EBIT-EPS indifference point.
B.Graphically determine the EBIT-EPS indifference point

c. What happens to the indifference point if the interest rate on debt increases and the common stock sales price remains constant?
d. What happens to the indifference point if the interest rate on debt remains constant and the common stock sales prices increases?
5) Morton Industries is considering opening a new subsidiary in Boston, to be operated as a separate company. The company’s financial analysts expect the new facility’s average EBIT level to be \$6 million per year. At this time, the company is considering the following two financing plans (use a 40 percent marginal tax rate in your analysis):

a. Calculate the EBIT-EPS indifference point.
b. Calculate the expected EPS for both financing plans.
c. What factors should the company consider in deciding which financing plan to adopt?
d. Which plan do you recommend the company adopt?
e. Suppose Morton adopts Plan 2, and the Boston facility initially operates at an annual EBIT level of \$6 million. What is the times interest earned ratio?
6) Moon and Chittenden are considering a new Internet venture to sell used textbooks. The project requires \$300,000 in financing. Two alternatives have been proposed.

Plan 1 (Common equity financing). Sell 30, 000 shares of stock at a net price of \$10 per share.
Plan 2 (Debt equity financing). Sell a combination of 15,000 shares of stock at a net price of \$10 per share and \$150,000 of long-term debt at a pretax interest rate of 12 percent.

Assume the corporate tax rate is 40 percent.

a. Compute the indifference level of EBIT between these two alternatives
b. If the firm’s EBIT next year has an expected value of \$25,000, which plan would you recommend assuming maximizing EPS is a valid objective?