Chapter: leverage

For a manufacturing company, apply leverage analysis using the

following data
 Price per machine is $10.
 Variable cost of $7.50,
 Fixed operating costs are 7,000 per year,
 Interest expense is $10,000
 Preferred stock dividend is $800 per year.
 At this point, you're selling 10,000 machine per year
 22.5% taxes rate
 Number of outstanding common shares are 5,000 shares.

Required:
i. Calculate EBIT
ii. Calculate your degree of operating leverage DOL
iii. Calculate your degree of financial leverage DFL
iv. Calculate your degree of total leverage DTL
v. Calculate the breakeven quantity
vi. Calculate the effect on EBIT and EAC in case of sales increase by
30%
vii. Calculate earnings available for common shareholders EPS

Answer
Answer
18,00
EBIT
0
DOL 1.39
DFL 2.58
DTL 3.59
Breakeven Q 2,800

Changes in EBIT
41.67
Change in EBIT in %
%
Change in EBIT in value 7,500
25,50
-New EBIT
0

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Changes in Net profits
107.6
Change in Net profits in %
4%
Change in Net profits in value 5,813
11,21
New Net profits
3

Answer
18,00 EBIT = 10,000 × (10 – 7.5) –
EBIT 0 7000

[1,000 × ( 10−7.5 ) ]
DOL=
DOL 1.389 ¿¿

[18,000 ]
DFL=
¿¿
DFL 2.583

DTL 3.588 DTL = 1.39 × 2.58

7000
Breakeven Q 2,800 Q=
10−7.5

Changes in EBIT
41.66 % Δ EBIT= DOL × % change in
Change in EBIT in % 7% Sales % Δ EBIT= 1.389× 30%
Change in EBIT in $ Δ EBIT= 41.667%×
7,500 $ Δ EBIT= % Δ EBIT× EBIT
value 18,000
25,50
New EBIT 0
New EBIT= $ Δ EBIT + EBIT New EBIT= 7,500 + 18,000

Changes in EAC
107.6 % Δ EAC = DTL × % change in % Δ EAC = 3.588 ×
Change in EAC in % 4% Sales 30%
Change in EAC in $ Δ EAC = 107.64%
5,813 $ Δ EAC = % Δ EAC × EAC
value × 5,400
11,21 New EAC = 5,813 +
New EAC New EAC = $ Δ EAC + EAC
3 5,400

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Income statement
100,0
Sales
00
75,00
Variable Cost
0
Fixed cost 7,000
18,00
EBIT
0
10,00
Less Interest
0
EBT 8,000
Less Taxes 1,800
EAT 6,200
PD 800
Earnings Available for Common
5,400
Stockholders
EPS
1.08

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Chapter: Capital budgeting
If the cost of capital is 17%. The firm has estimate the cash inflows
associated with the proposal as shown in the following table:
Project X Project Y
Initial investment 350,000 200,000

Year Operating cash inflows

1 150,000 80,000
2 100,000 80,000
3 75,000 80,000
4 200,000 80,000
Payback period
1) Calculate the payback period for the proposed projects.
2) Based on Payback period, rank the two projects
3) If the company has maximum payback period of 3.0 years, which project
would be accepted, and why?
NPV
4) Calculate the net present value (NPV) for the proposed investments using the
cost of capital 17%.
5) Based on NPV, rank the two projects.
6) Based on the NPV, are these two projects accepted or rejected and why?
7) If these two projects are mutually inclusive, which project/s would be
implemented?
IRR
8) Calculate the IRR for the proposed investments
9) Based on IRR, rank the two projects.
10) Based on IRR, are these two projects accepted or rejected and why?

Answer
1) Payback period X:3.125 and Y:2.50
2) Project Y, is better because it has a shorter payback period
3) I would accept only project Y because it is less than the maximum accepted
payback period
4) NPV are X:4,814 and Y:19,459
5) Project Y is better because it has higher net present value

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6) Both are accepted because both have positive values
7) If these are mutually exclusive I had to choose only one, so project Y will be
the only project to be implemented

8) IRR X:17.68%, and Y: 21.86

9) Project Y is better because it has higher IRR
10) Since both projects have higher IRR than the cost of capital 17%, so
both are accepted

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Chapter: Options-
Find the profits/losses for the following options

cost
of strike price at
Option type
optio price expiration
n
A call 1,500 200 210
B put 3,500 600 550

Answer
Call
Cost per share 15
Total Cost Per
share 215
Profit/Loss per -
share 5.00
Total Profit/Loss -500

Put
Cost per share 35
Total Cost Per
share 585
Profit/Loss per 15.0
share 0
1,50
Total Profit/Loss 0

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Chapter : Risk and Return
Using the table above, calculate the following
i. The expected rate of return
ii. Expected risk using standard deviation
iii. The coefficient of variation
iv. Which project is better and why?

Asset A Asset B

Rate of Return Probability Rate of Return Probability

3% 25% -5% 30%

10% 50% 30% 50%
30% 25% 70% 20%

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Answer
Expected rate of return
Asset A
Rate of
Probability r x pr
Return
3% 25% 0.75%
10% 50% 5.00%
30% 25% 7.50%
expected r 13.25%

Asset B
Rate of
Probability r x pr
Return
-5% 30% -1.50%
30% 50% 15.00%
70% 20% 14.00%
expected r 27.50%

Standard Deviation
Asset A

Rate of Return Probability

3.0% 25.0% -10.3% 1.0506% 0.2627%
10.0% 50.0% -3.3% 0.1% 0.0528%
30.0% 25.0% 16.8% 2.8056% 0.7014%

Var 1.0169%

Std Dev 10.08%

Asset B

Rate of Return Probability

-5.0% 30.0% -32.5% 10.5625% 3.1688%
30.0% 50.0% 2.5% 0.1% 0.0312%
70.0% 20.0% 42.5% 18.0625% 3.6125%

Var 6.8125%
Std Dev 26.10%

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Coefficient of Variation
CVA 0.76
CVB 0.95

Which one is better

Asses A is better because it has lower CV

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