Homework Chapter 5
2.
Break-even analysis (LO2) The Hartnett Corporation manufactures baseball bats
with Pudge Rodriguez's autograph stamped on them. Each bat sells for $13 and
has a variable cost of $8. There are $20,000 in fixed costs involved in the
production process.
a.
Compute the break-even point in units.
b.
Find the sales (in units) needed to earn a profit of $15,000.
6.
Break-even analysis (LO2) Jay Linoleum Company has fixed costs of $70,000.
Its product currently sells for $4 per unit and has variable costs per unit of $2.60.
Mr. Thomas, the head of manufacturing, proposes to buy new equipment that will
cost $300,000 and drive up fixed costs to $105,000. Although the price will
remain at $4 per unit, the increased automation will reduce variable costs per unit
to $2.25.
As a result of Thomas's suggestion, will the break-even point go up or down?
Compute the necessary numbers.
11. Degree of leverage (LO2 & 5) The Harding Company manufactures skates. The
company's income statement for 2010 is as follows:
HARDING COMPANY
Income Statement
For the Year Ended December 31, 2010
Sales (10,000 skates @ $50 each) .................................
Less: Variable costs (10,000 skates at $20) ..................
Fixed costs .................................................................
Earnings before interest and taxes (EBIT) ....................
Interest expense .............................................................
Earnings before taxes (EBT) .........................................
Income tax expense (40%) ............................................
Earnings after taxes (EAT) ............................................
$500,000
200,000
150,000
150,000
60,000
90,000
36,000
$ 54,000
Given this income statement, compute the following:
a.
b.
c.
d.
12.
Degree of operating leverage.
Degree of financial leverage.
Degree of combined leverage.
Break-even point in units (number of skates).
Break-even point and degree of leverage (LO2 & 5) Mo & Chris's Delicious
Burgers, Inc., sells food to Military Cafeterias for $15 a box. The fixed costs of
this operation are $80,000, while the variable cost per box is $10.
a.
What is the break-even point in boxes?
b.
Calculate the profit or loss on 15,000 boxes and on 30,000 boxes.
c.
d.
e.
What is the degree of operating leverage at 20,000 boxes and at 30,000
boxes?
Why does the degree of operating leverage change as the quantity sold
increases?
If the firm has an annual interest expense of $10,000, calculate the degree of
financial leverage at both 20,000 and 30,000 boxes.
What is the degree of combined leverage at both sales levels?
13.
Break-even point and degree of leverage (LO2 & 5) United Snack Company
sells
50-pound bags of peanuts to university dormitories for $10 a bag. The fixed costs
of this operation are $80,000, while the variable costs of peanuts are $.10 per
pound.
a.
What is the break-even point in bags?
b.
Calculate the profit or loss on 12,000 bags and on 25,000 bags.
c.
What is the degree of operating leverage at 20,000 bags and at 25,000 bags?
Why does the degree of operating leverage change as the quantity sold
increases?
d.
If United Snack Company has an annual interest expense of $10,000,
calculate the degree of financial leverage at both 20,000 and 25,000 bags.
e.
What is the degree of combined leverage at both sales levels?
15.
Use of different formulas for operating leverage (LO3) U.S. Steal has the
following income statement data:
Total
Variable
Costs
$ 80,000
120,000
Units
Sold
40,000
60,000
a.
Fixed
Costs
$50,000
50,000
Total
Revenue
$160,000
240,000
Compute DOL based on the formula below (see page 128 for an example):
DOL 
b.
Total
Costs
$130,000
170,000
Operating
Income
(Loss)
$30,000
70,000
Percent change in operating income
Percent change in units sold
Confirm that your answer to part a is correct by recomputing DOL using
formula 5–3 on page 129. There may be a slight difference due to rounding.
DOL 
Q(P  VC)
Q(P  VC)  FC
Q represents beginning units sold (all calculations should be done at this
level).
P can be found by dividing total revenue by units sold.
VC can be found by dividing total variable costs by units sold.
16.
Earnings per share and financial leverage (LO4) Cain Auto Supplies and Able
Auto Parts are competitors in the aftermarket for auto supplies. The separate
capital structures for Cain and Able are presented below.
Cain
Debt @ 10%........................$ 50,000
Common stock, $10 par ...... 100,000
Total ................................$150,000
Common shares .................. 10,000
a.
b.
c.
Able
Debt @ 10% .................. $100,000
Common stock, $10
50,000
par. .................................
Total ............................... $150,000
Common shares .............
5,000
Compute earnings per share if earnings before interest and taxes are $10,000,
$15,000, and $50,000 (assume a 30 percent tax rate).
Explain the relationship between earnings per share and the level of EBIT.
If the cost of debt went up to 12 percent and all other factors remained equal,
what would be the break-even level for EBIT?
19. Japanese firm and combined leverage (LO5) Firms in Japan often employ both
high operating and financial leverage because of the use of modern technology
and close borrower-lender relationships. Assume the Mitaka Company has a sales
volume of 125,000 units at a price of $25 per unit; variable costs are $5 per unit
and fixed costs are $1,800,000. Interest expense is $400,000. What is the degree
of combined leverage for this Japanese firm?
21. Expansion and leverage (LO5) The Norman Automatic Mailer Machine
Company is planning to expand production because of the increased volume of
mailouts. The increased mailout capacity will cost $2,000,000. The expansion can
be financed either by bonds at an interest rate of 12 percent or by selling 40,000
shares of common stock at $50 per share. The current income statement (before
expansion) is as follows:
NORMAN AUTOMATIC MAILER
Income Statement
201X
Sales.
$3,000,000
Less: Variable costs (40%). ........................... $1,200,000
Fixed costs ..................................................
800,000
Earnings before interest and taxes ....................
Less: Interest expense ....................................
Earnings before taxes .......................................
Less: Taxes (@ 35%) ....................................
Earnings after taxes ..........................................
Shares ...............................................................
Earnings per share ............................................
1,000,000
400,000
600,000
210,000
$ 390,000
100,000
$
3.90
Assume that after expansion, sales are expected to increase by $1,500,000.
Variable costs will remain at 40 percent of sales, and fixed costs will increase by
$550,000. The tax rate is 35 percent.
a.
Calculate the degree of operating leverage, the degree of financial leverage,
and the degree of combined leverage before expansion.
b.
Construct the income statement for the two financial plans.
c.
Calculate the degree of operating leverage, the degree of financial leverage,
and the degree of combined leverage, after expansion, for the two financing
plans.
d.
Explain which financing plan you favor and the risks involved.