Finance

P12-4 Breakeven analysis Barry Carter is considering opening a music store. He wants to estimate the number of CDs he must sell to break even. The CDs will be sold for $13.98 each, variable operating costs are $10.48 per CD, and annual fixed operating costs are $73,500. a. Find the operating breakeven point in number of CDs. b. Calculate the total operating costs at the breakeven volume found in part a. c. If Barry estimates that at a minimum he can sell 2,000 CDs per month, should he go into the music business' d. How much EBIT will Barry realize if he sells the minimum 2,000 CDs per month noted in part c' P12-4 Answers a. 21,000 CDs b. Total Operating Costs = FC + (Q x VC) = $73,500 + (21,000 x $10.48) = $293,580 c. Yes, Barry should go into the music business because 2,000 x 12 = 24,000 CDs, which is more than the breakeven amount by 3,000 CDs per year. d. EBIT = (P x Q) – FC – (VC x Q) = (13.98 x 24,000) – 73,500 – (10.48 x 24,000) = $335,520 – 73,500 – 251,520 = $10,500 ****************************************************************************************** P12-11 EPS calculations Southland Industries has $60,000 of 16% (annual interest) bonds outstanding, 1,500 shares of preferred stock paying annual dividend of $5 per share, and 4,000 shares of common stock outstanding. Assuming that the firm has a 40% tax rate, compute earnings per share (EPS) for the following levels of EBIT: a. $24,600 b. $30,600 c. $35,000 P12-11 Answers P12-24 Integrative – Optimal capital structure Medallion Cooling Systems, Inc., has total assets of $10,000,000, EBIT of $2,000,000, and preferred dividends of $200,000 and is taxed at a rate of 40%. In an effort to determine the optimal capital structure, the firm has assembled data on the cost of debt, the number of shares of common stock for various levels of indebtedness, and the overall required return on investment: a. Calculate earnings per share for each level of indebtedness. b. Use Equation 12.12 and the earnings per share calculated in part a to calculate a price per share for each level of indebtedness. c. Choose the optimal capital structure. Justify your choice. P12-24 Answers Problem 12.24 Assets = $10,000,000 Debt Ratio 0% 15% 30% 45% 60% Total Debt 0 1,500,000 3,000,000 4,500,000 6,000,000 Less Interest 0 120,000 270,000 540,000 900,000 EBIT 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000 Less Interest 0 120,000 270,000 540,000 900,000 EBT 2,000,000 1,880,000 1,730,000 1,460,000 1,100,000 Taxes @ 40% 800,000 752,000 692,000 584,000 440,000 Net Profit 1,200,000 1,128,000 1,038,000 876,000 660,000 Less Preferred dividends 200,000 200,000 200,000 200,000 200,000 Profits available to common stock 1,000,000 928,000 838,000 676,000 460,000 # Shares Outstanding 200,000 170,000 140,000 110,000 80,000 a. EPS $5.00 $5.46 $5.99 $6.15 $5.75 Po = EPS/Ks Debt Ratios 0% 15% 30% 45% 60% b Stock Price 41.67 41.99 42.79 38.44 28.75 c Determine which scenario provides the optimal capital structure in other words which debt ratio maximizes the stock price' The optimal capital structure is 30% debt and 70% equity because this will maximize the price of the common stock. P16-2 Loan interest For each of the loan amounts, interest rates, annual payments, and loan terms shown in the following table, calculate the annual interest paid each year over the terms of the loan, assuming that the payments are made at the end of each year. P16-2 Answers P16-5 Lease versus purchase Northwest Lumber Company needs to expand its facilities. To do so, the firm must acquire a machine costing $80,000. The machine can be leased or purchased. The firm is in the 40% tax bracket, and its after-tax cost of debt is 9%. The terms of the lease and purchase plans are as follows: