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Chapter5Exercises
5-1.ShockElectronicssellsportableheatersfor$25perunitandthevariablecosttoproducethemis$17.Mr.Ampsestimatesthatthefixedcostsare$96,000.
Computethebreak-evenpointinunits.
Fillinthetablebelow(indollars)toillustratethatthebreak-evenpointhasbeenachieved.
Solution:
Sales
–Fixedcosts
–totalvariablecosts Netprofit(loss)
ShockElectronics
BE
Fixedcosts
Price-variablecostperunit
$96,000
$25$17
$96,00012,000units
$8
Sales $300,000(12,000units*$25)
–Fixedcosts 96,000
–Totalvariablecosts 204,000(12,000units*$17)Netprofit(loss) $ 0
5-3. TherapeuticSystemssellsitsproductsfor$8perunit.Ithasthefollowingcosts:
Rent $120,000
Factorylabor $1.50perunitExecutivesalaries $112,000
Rawmaterial $ .70perunit
Separatetheexpensesbetweenfixedandvariablecostperunit.Usingthisinformationandthesalespriceperunitof$6,computethebreak-evenpoint.
Solution:
TherapeuticSystems
FixedCosts
VariableCosts(perunit)
Rent
$120,000
Factorylabor
$1.50
Executivesalaries
$112,000
Rawmaterials
.70
$232,000
$2.20
BE
FC
PVC
$232,000
$8.00$2.20
$232,00040,000units
$5.80
5-4. Drawtwobreak-evengraphs—oneforaconservativefirmusinglabor-intensiveproductionandanotherforacapital-intensivefirm.Assumingthesecompaniescompetewithinthesameindustryandhaveidenticalsales,explaintheimpactofchangesinsalesvolumeonbothfirms'profits.
Solution:
Labor-Intensiveandcapital-intensivebreak-evengraphs
Labor-Intensive Capital-Intensive
Revenueandcosts
Totalrevenue
Totalcosts
Totalrevenue
Profits
BE Variable
Cost
Fixedcosts
Revenueandcosts
Totalcosts
Profits
BE
VariableCost
Fixedcosts
Unitsproducedandsold Unitsproducedandsold
Thecompanyhavingthehighfixedcostswillhavelowervariablecoststhanitscompetitorsinceithassubstitutedcapitalforlabor.Withalowervariablecost,thehighfixedcostcompanywillhavealargercontributionmargin.Therefore,whensalesrise,itsprofitswillincreasefasterthanthelowfixed
costfirmandwhenthesalesdecline,thereversewillbetrue.
5-8. TheHardingCompanymanufacturesskates.Thecompany'sincomestatementfor2001isasfollows:
HardingCompanyIncomeStatement
FortheYearEndedDecember31,2001
Sales(10,000skates@$50each)...........................
$500,000
Less:Variablecosts(10,000skatesat$20)........
200,000
Fixedcosts......................................................
150,000
Earningsbeforeinterestandtaxes(EBIT)..............
150,000
Interestexpense.......................................................
60,000
Earningsbeforetaxes(EBT)...................................
90,000
Incometaxexpense(40%)......................................
36,000
Earningsaftertaxes(EAT).....................................
$54,000
Giventhisincomestatement,computethefollowing:
Degreeofoperatingleverage.
Degreeoffinancialleverage.
Degreeofcombinedleverage.
Break-evenpointinunits(numberofskates).
Solution:
HardingCompany
Q=10,000,P=$50,VC=$20,FC=$150,000,I=$60,000
DOL QPVC
QPVCFC
10,000$50$20
10,000$50$20$150,000
10,000$30
10,000$30$150,000
$300,000
$300,000$150,000
$300,0002.00x
$150,000
DFL
EBITEBITI
$150,000
$150,000$60,000
$150,0001.67x
$90,000
Q
DCL
QPVC
PVCFCI
10,000
$50$20$150,000$60,000
10,000$50$20
$10,000$30 $300,0003.33x
$10,000$30$210,000 $90,000
BE
$150,000
$50$20
$150,0005,000skates
$30
5-12. SterlingOpticalandRoyalOpticalbothmakeglassframesandeachisabletogenerateearningsbeforeinterestandtaxesof$120,000.
TheseparatecapitalstructuresforSterlingandRoyalareshownbelow:
Sterling
Royal
Debt@12% $
600,000
Debt@12% $
200,000
Commonstock,$5par 400,000
Commonstock,$5par..
800,000
Total $1,000,000
Total..........................
$1,000,000
Commonshares................ 80,000
Commonshares.............
160,000
Computeearningspershareforbothfirms.Assumea25percenttaxrate.
Inparta,youshouldhavegottenthesameanswerforbothcompanies'
Solution:
a.
earningspershare.AssumeaP/Eratioof20foreachcompany,whatwoulditsstockpricebe?
Nowaspartofyouranalysis,assumetheP/Eratiowouldbe16fortheriskiercompanyintermsofheavydebtutilizationinthecapitalstructureand25forthelessriskycompany.Whatwouldthestockpricesforthetwofirmsbeundertheseassumptions?(Note:Althoughinterestratesalsowouldlikelybedifferentbasedonrisk,weholdthemconstantforeaseofanalysis).
Basedontheevidenceinpartc,shouldmanagementonlybeconcernedabouttheimpactoffinancingplansonearningspershareorshouldstockholders'wealthmaximization(stockprice)beconsideredaswell?
SterlingOpticalandRoyalOptical
Sterling
Royal
EBIT
$120,000
$120,000
Less:Interest
72,000
24,000
EBT
48,000
96,000
Less:Taxes@25%
12,000
24,000
EAT
36,000
72,000
Shares
80,000
160,000
EPS
$.45
$.45
Stockprice =P/E*EPS
20*$.45=$9.00
Sterling Royal
16*$.45=$7.20 25*$.45=$11.25
Clearly,theultimateobjectiveshouldbetomaximizethestockprice.Whilemanagementwouldbeindifferent
betweenthetwoplansbasedonearningspershare,Royal
Optical,withthelessriskyplan,hasahig
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