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Problem 4-1 Growth and financing [LO4]
Philip Morris is excited because sales for his clothing company are expected to double from $720,000 to
$1,440,000 next year. Philip notes that net assets (Assets – Liabilities) will remain at 40 percent of Sales.
His clothing firm will enjoy a 9 percent return on total sales. He will start the year with $320,000 in the bank
and is already bragging about the two Mercedes he will buy and the European vacation he will take.
(a) Compute his likely cash balance or deficit for the end of the year. Start with beginning cash and subtract
the asset buildup (equal to 40 percent of the sales increase) and add in profit. (Negative amount
should be indicated by a minus sign. Omit the “$” sign in your response.)
Ending cash balance $ 96800
(b) Does his optimistic outlook for his cash position appear to be correct?
No
Yes
rev: 11_18_2012
Worksheet Problem 4-1 Growth and financing [LO4]
Learning Objective: 04-04 The various methods of
forecasting enable the firm to determine the amount
of new funds required in advance.
Problem 4-3 Growth and financing [LO4]
Galehouse Gas Stations, Inc., expects sales to increase from $1,520,000 to $1,720,000 next year. Mr. Galehouse
believes that net assets (Assets – Liabilities) will represent 35 percent of sales. His firm has a 9 percent return on
sales and pays 50 percent of profits out as dividends
.
(a) What effect will this growth have on funds? (Negative amount should be indicated by a minus sign. Omit
the “$” sign in your response.)
The cash balance will change by $
.
(b) If the dividend payout is only 35 percent, what effect will this growth have on funds? (Omit the “$” sign in your
response.)
The cash balance will change by $
.
rev: 09_27_2012
Worksheet Problem 4-3 Growth and financing [LO4]
Learning Objective: 04-04 The various methods of
forecasting enable the firm to determine the amount
of new funds required in advance.
Problem 4-4 Sales projections
[LO2]
The Alliance Corp. expects to sell the following number of units of copper cables at the prices indicated,
under three different scenarios in the economy. The probability of each outcome is indicated.
Outcome Probability Units Price
A .70 225 $ 20
B .10 370 35
C .20 510 45
What is the expected value of the total sales projection? (Omit the “$” sign in your response.)
Total expected value $ 9035
Worksheet Problem 4-4 Sales projections [LO2]
Learning Objective: 04-02 The three financial
statements for forecasting are the pro forma income
statement, the cash budget, and the pro forma
balance sheet.
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Problem 4-6 Sales projections [LO2]
Cyber Security Systems had sales of 3,200 units at $50 per unit last year. The marketing manager projects
a 10 percent increase in unit volume sales this year with a 10 percent price increase. Returned
merchandise will represent 8 percent of total sales.
What is your net dollar sales projection for this year? (Omit the “$” sign in
your response.)
Net sales $
Worksheet Problem 4-6 Sales projections [LO2]
Learning Objective: 04-02 The three financial
statements for forecasting are the pro forma income
statement, the cash budget, and the pro forma
balance sheet.
Problem 4-8 Production requirements [LO2]
Sales for Western Boot Stores are expected to be 60,000 units for October. The company likes to maintain
30 percent of unit sales for each month in ending inventory (i.e., the end of October). Beginning inventory for
October is 18,500 units.
How many units should Western Boot produce for the coming month?
Units to be produced
View Hint #1
Worksheet Problem 4-8 Production requirements [LO2]
Learning Objective: 04-02 The three financial
statements for forecasting are the pro forma income
statement, the cash budget, and the pro forma
balance sheet.
Problem 4-11 Cost of goods sold-FIFO [LO2]
On December 31 of last year, Wolfson Corporation had in inventory 610 units of its product, which cost $18
per unit to produce. During January, the company produced 1,010 units at a cost of $21 per unit.
Assuming that Wolfson Corporation sold 1,120 units in January, what was the cost of goods sold (assume
FIFO inventory accounting)? (Omit the “$” sign in your response.)
Cost of goods sold $
Worksheet Problem 4-11 Cost of goods sold-FIFO [LO2]
Learning Objective: 04-02 The three financial
statements for forecasting are the pro forma income
statement, the cash budget, and the pro forma
balance sheet.
Problem 4-13 Cost of goods sold-LIFO and FIFO [LO2]
At the end of January, Mineral Labs had an inventory of 955 units, which cost $12 per unit to produce.
During February the company produced 1,800 units at a cost of $16 per unit.
(a) If the firm sold 2,650 units in February, what was the cost of goods sold? (Assume LIFO inventory
accounting.) (Omit the “$” sign in your response.)
Cost of goods sold $
(b) If the firm sold 2,650 units in February, what was the cost of goods sold? (Assume FIFO inventory
accounting.) (Omit the “$” sign in your response.)
Cost of goods sold $
Worksheet
Problem 4-13 Cost of goods sold-LIFO and FIFO
[LO2]
Learning Objective: 04-02 The three financial
statements for forecasting are the pro forma income
statement, the cash budget, and the pro forma
balance sheet.
javascript:doHint(‘13252699176164608’, ”, ‘%3Ca+href%3D%22http%3A%2F%2Flectures.mhhe.com%2Fconnect%2F0077316215%2F13-4-7.html%22+target%3D%22_blank%22%3EGuided+Example%3C%2Fa%3E’);
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Problem 4-14 Gross profit and ending inventory [LO2]
The Bradley Corporation produces a product with the following costs as of July 1, 2011:
Material $ 5 per unit
Labor 3 per unit
Overhead 1 per unit
Beginning inventory at these costs on July 1 was 3,700 units. From July 1 to December 1, 2011,
Bradley produced 13,400 units. These units had a material cost of $2, labor of $3, and overhead of $4 per
unit. Bradley uses FIFO inventory accounting.
(a) Assuming that Bradley sold 14,400 units during the last six months of the year at $14 each, what would
gross profit be? (Omit the “$” sign in your response.)
Gross profit $
(b) What is the value of ending inventory? (Omit the “$” sign in your response.)
Ending inventory $
View Hint #1
Worksheet Difficulty: Intermediate
Problem 4-14 Gross profit and ending inventory
[LO2]
Learning Objective: 04-02 The three financial
statements for forecasting are the pro forma income
statement, the cash budget, and the pro forma
balance sheet.
Problem 4-15 Gross profit and ending inventory [LO2]
The Bradley Corporation produces a product with the following costs as of July 1, 2011:
Material $ 4 per unit
Labor 4 per unit
Overhead 2 per unit
Beginning inventory at these costs on July 1 was 4,000 units. From July 1 to December 1, 2011,
Bradley produced 14,000 units. These units had a material cost of $2, labor of $3, and overhead of $4 per
unit. Bradley uses LIFO inventory accounting.
(a) Assuming that Bradley sold 17,000 units during the last six months of the year at $14 each, what would
gross profit be? (Omit the “$” sign in your response.)
Gross profit $
(b) What is the value of ending inventory? (Omit the “$” sign in your response.)
Ending inventory $
Worksheet Difficulty: Intermediate
Problem 4-15 Gross profit and ending inventory
[LO2]
Learning Objective: 04-02 The three financial
statements for forecasting are the pro forma income
statement, the cash budget, and the pro forma
balance sheet.
Problem 4-19 Schedule of cash receipts [LO2]
Watt’s Lighting Stores made the following sales projections for the next six months. All sales are credit
sales.
March $ 48,000 June $ 52,000
April 54,000 July 60,000
May 43,000 August 62,000
Sales in January and February were $51,000 and $50,000, respectively.
Experience has shown that of total sales, 10 percent are uncollectible, 35 percent are collected in the
month of sale, 45 percent are collected in the following month, and 10 percent are collected two months
after sale.
(a) Prepare a monthly cash receipts schedule for the firm for March through August. (Omit the “$” sign in
javascript:doHint(‘13252699176211723’, ”, ‘%3Ca+href%3D%22http%3A%2F%2Flectures.mhhe.com%2Fconnect%2F0077316215%2F13-4-13.html%22+target%3D%22_blank%22%3EGuided+Example%3C%2Fa%3E’);
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your response.)
WATT’S LIGHTING STORES
Cash Receipts Schedule
January February March April May June July August
Sales $ $ $ $ $ $ $ $
Collections of current sales
Collections of prior month’s sales
Collections of sales 2 months
earlier
Total cash receipts $ $ $ $ $ $
(b) Of the sales expected to be made during the six months from March through August, how much will still
be uncollected at the end of August? How much of this is expected to be collected later? (Omit the “$”
sign in your response.)
Amount
Uncollected $
Expected to be collected $
Worksheet Difficulty: Intermediate
Problem 4-19 Schedule of cash receipts [LO2]
Learning Objective: 04-02 The three financial
statements for forecasting are the pro forma income
statement, the cash budget, and the pro forma
balance sheet.
Problem 4-23 Schedule of cash payments [LO2]
The Volt Battery Company has forecast its sales in units as follows:
January 2,300 May 2,850
February 2,150 June 3,000
March 2,100 July 2,700
April 2,600
Volt Battery always keeps an ending inventory equal to 130% of the next month’s expected sales. The
ending inventory for December (January’s beginning inventory) is 2,990 units, which is consistent with this
policy.
Materials cost $12 per unit and are paid for in the month after purchase. Labor cost is $5 per unit and is
paid in the month the cost is incurred. Overhead costs are $13,500 per month. Interest of $9,500 is
scheduled to be paid in March, and employee bonuses of $14,700 will be paid in June.
(a) Prepare a monthly production schedule for January through June.
VOLT BATTERY COMPANY
Production Schedule
Jan. Feb. March April May June July
Forecasted unit sales
Desired ending inventory
Beginning inventory
Units to be produced
(b) Prepare a monthly summary of cash payments for January through June. Volt produced 2,100 units in
December. (Omit the “$” sign in your response.)
VOLT BATTERY COMPANY
Summary of Cash payments
Dec. Jan. Feb. March April May June
Units produced
Material cost $ $ $ $ $ $
Labor cost
Overhead cost
Interest
Employee bonuses
Total cash payments $ $ $ $ $ $
rev: 09_21_2012 11_12_2012
Worksheet Difficulty: Intermediate
Learning Objective: 04-02 The three financial
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5.00 points
Problem 4-23 Schedule of cash payments [LO2] statements for forecasting are the pro forma income
statement, the cash budget, and the pro forma
balance sheet.
Problem 4-25 Complete cash budget [LO2]
Harry’s Carryout Stores has eight locations. The firm wishes to expand by two more stores and needs a
bank loan to do this. Mr. Wilson, the banker, will finance construction if the firm can present an acceptable
three-month financial plan for January through March. The following are actual and forecasted sales figures:
Actual Forecast Additional Information
November $ 270,000 January $ 420,000 April forecast $ 410,000
December 360,000 February 460,000
March 420,000
Of the firm’s sales, 30 percent are for cash and the remaining 70 percent are on credit. Of credit sales, 40
percent are paid in the month after sale and 60 percent are paid in the second month after the sale.
Materials cost 40 percent of sales and are purchased and received each month in an amount sufficient to
cover the following month’s expected sales. Materials are paid for in the month after they are received.
Labor expense is 25 percent of sales and is paid for in the month of sales. Selling and administrative
expense is 25 percent of sales and is also paid in the month of sales. Overhead expense is $31,500 in
cash per month.
Depreciation expense is $10,700 per month. Taxes of $8,700 will be paid in January, and dividends of
$5,500 will be paid in March. Cash at the beginning of January is $94,000, and the minimum desired cash
balance is $89,000.
(a) Prepare a schedule of monthly cash receipts for January, February and March. (Omit the “$” sign in
your response.)
HARRY’S CARRY-OUT STORES
Cash Receipts Schedule
November December January February March April
Sales $ $ $ $ $ $
Cash sales
Credit sales
Collections in the month
after credit sales)
Collections two months
after credit sales)
Total cash receipts $ $ $
(b) Prepare a schedule of monthly cash payments for January, February and March. (Omit the “$” sign in
your response.)
HARRY’S CARRY-OUT STORES
Cash Payments Schedule
January February March
Payments for purchases $ $ $
Labor expense
Selling and admin. exp.
Overhead
Taxes
Dividends
Total cash payments $ $ $
(c) Prepare a schedule of monthly cash budget with borrowings and repayments for January, February and
March. (Leave no cells blank – be certain to enter “0” wherever required. Negative amounts
should be indicated by a minus sign. Omit the “$” sign in your response.)
HARRY’S CARRY-OUT STORES
Cash Budget
January February March
Total cash receipts $ $ $
Total cash payments
Net cash flow
Beginning cash balance
Cumulative cash balance
Monthly loan or (repayment)
Cumulative loan balance
Ending cash balance $ $ $
rev: 07_17_2012
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Worksheet Difficulty: Advanced
Problem 4-25 Complete cash budget [LO2]
Learning Objective: 04-02 The three financial
statements for forecasting are the pro forma income
statement, the cash budget, and the pro forma
balance sheet.
Problem 4-28 Percent-of-sales method [LO3]
The Manning Company has financial statements as shown below, which are representative of the
company’s historical average.
The firm is expecting a 40 percent increase in sales next year, and management is concerned about the
company’s need for external funds. The increase in sales is expected to be carried out without any
expansion of fixed assets, but rather through more efficient asset utilization in the existing store. Among
liabilities, only current liabilities vary directly with sales.
Income Statement
Sales $300,000
Expenses 246,800
Earnings before interest and taxes $ 53,200
Interest 9,100
Earnings before taxes $ 44,100
Taxes 17,100
Earnings after taxes $ 27,000
Dividends $ 5,400
Balance Sheet
Assets Liabilities and Stockholders’ Equity
Cash $ 9,000 Accounts payable $ 29,000
Accounts receivable 56,000 Accrued wages 2,250
Inventory 70,000 Accrued taxes 4,750
Current assets $135,000 Current liabilities $ 36,000
Fixed assets 86,000 Notes payable 9,100
Long-term debt 25,500
Common stock 125,000
Retained earnings 25,400
Total assets $221,000
Total liabilities and
stockholders’ equity $221,000
Using the percent-of-sales method, determine the amount of external financing needs, or a surplus of funds
required by the company. (Hint: A profit margin and payout ratio must be found from the income
statement.) (Do not round intermediate calculations. Input the amount as positive value. Omit the
“$” sign in your response.)
The firm (Click to select) $ in (Click to select) .
rev: 09_10_2011
Worksheet Difficulty: Advanced
Problem 4-28 Percent-of-sales method [LO3]
Learning Objective: 04-03 The percent-of-sales
method may also be used for forecasting on a less
precise basis.
Problem 5-2 Break-even analysis [LO2]
The Hartnett Corporation manufactures baseball bats with Pudge Rodriguez’s autograph stamped on them.
Each bat sells for $29 and has a variable cost of $16. There are $27,950 in fixed costs involved in the
production process.
(a) Compute the break-even point in units. (Round your answer to the nearest whole number.)
Break-even point units
(b) Find the sales (in units) needed to earn a profit of $21,385.
Sales units
rev: 01_18_2013
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Worksheet Difficulty: Basic
Problem 5-2 Break-even analysis [LO2]
Learning Objective: 05-02 Break-even analysis
allows the firm to determine the magnitude of
operations necessary to avoid loss.
Problem 5-5 Break-even analysis [LO2]
Eaton Tool Company has fixed costs of $464,600, sells its units for $98, and has variable costs of $52 per
unit.
(a) Compute the break-even point.
Break-even point units
(b) Ms. Eaton comes up with a new plan to cut fixed costs to $360,000. However, more labor will now be
required, which will increase variable costs per unit to $55. The sales price will remain at $98. What is
the new break-even point? (Round your answer to the nearest whole number.)
New break-even point units
(c) Under the new plan, what is likely to happen to profitability at very high volume levels (compared to the
old plan)?
Profitability will be less
Profitability will be more
Worksheet Difficulty: Basic
Problem 5-5 Break-even analysis [LO2]
Learning Objective: 05-02 Break-even analysis
allows the firm to determine the magnitude of
operations necessary to avoid loss.
Problem 5-8 Cash break-even analysis [LO2]
Air Purifier, Inc., computes its break-even point strictly on the basis of cash expenditures related to fixed
costs. Its total fixed costs are $2,410,000, but 10 percent of this value is represented by depreciation. Its
contribution margin (price minus variable cost) for each unit is $32. How many units does the firm need to
sell to reach the cash break-even point? (Round your answer to the nearest whole number.)
Cash break-even point units
Worksheet Difficulty: Basic
Problem 5-8 Cash break-even analysis [LO2]
Learning Objective: 05-02 Break-even analysis
allows the firm to determine the magnitude of
operations necessary to avoid loss.
Problem 5-9 Cash break-even analysis [LO2]
Boise Timber co. computes its break-even point strictly on the basis of cash expenditures related to fixed
costs. Its total fixed costs are $8,400,000, but 25 percent of this value is represented by depreciation. Its
contribution margin (price minus variable cost) for each unit is $28. How many units does the firm need to
sell to reach the cash break-even point? (Round your answer to the nearest whole number.)
Cash break-even point units
Worksheet Difficulty: Basic
Problem 5-9 Cash break-even analysis [LO2]
Learning Objective: 05-02 Break-even analysis
allows the firm to determine the magnitude of
operations necessary to avoid loss.
Problem 5-11 Degree of
leverage [LO2, 5]
The Harding Company manufactures skates. The company’s income statement for 2010 is as follows:
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2.00 points
HARDING COMPANY
Income Statement
For the Year Ended December 31, 2010
Sales (12,100 skates @ $92 each) $ 1,113,200
Less: Variable costs (12,100 skates at $41) 496,100
Fixed costs 360,000
Earnings before interest and taxes (EBIT) 257,100
Interest expense 70,500
Earnings before taxes (EBT) 186,600
Income tax expense (40%) 74,640
Earnings after taxes (EAT) $ 111,960
(a) Compute the degree of operating leverage. (Enter only numeric value rounded to 2 decimal
places.)
Degree of operating leverage
(b) Compute the degree of financial leverage. (Enter only numeric value rounded to 2 decimal places.)
Degree of financial leverage
(c) Compute the degree of combined leverage. (Enter only numeric value rounded to 2 decimal
places.)
Degree of combined leverage
(d) Compute the break-even point in units (number of skates). (Round your answer to the nearest whole
number.)
Break-even point stakes
Worksheet Difficulty: Intermediate
Learning Objective: 05-05 Combined leverage takes
into account both the use of fixed assets and debt.
Problem 5-11 Degree of leverage [LO2, 5]
Learning Objective: 05-02 Break-even analysis
allows the firm to determine the magnitude of
operations necessary to avoid loss.
Problem 5-12 Break-even point and degree of leverage [LO2, 5]
Mo & Chris’s Delicious Burgers, Inc., sells food to Military Cafeterias for $63 a box. The fixed costs of this
operation are $403,100, while the variable cost per box is $34.
(a) What is the break-even point in boxes?
Break-even point boxes
(b) Calculate the profit or loss on 15,000 boxes and on 30,000 boxes. (Input all amounts as positive
values. Omit the “$” sign in your response.)
Boxes Profit/Loss Amount
15,000 (Click to select) $
30,000 (Click to select) $
(c) What is the degree of operating leverage at 19,000 boxes and at 30,000 boxes? (Enter only numeric
value rounded to 2 decimal places.)
Boxes
Degree of
operating leverage
19,000
30,000
(d) If the firm has an annual interest expense of $12,400, calculate the degree of financial leverage at both
19,000 and 30,000 boxes.(Enter only numeric value rounded to 2 decimal places.)
Boxes
Degree of
financial leverage
19,000
30,000
(e) What is the degree of combined leverage at both sales levels? (Enter only numeric value rounded to
2 decimal places.)
Boxes
Degree of
combined leverage
19,000
30,000
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22.
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2.00 points
rev: 02_23_2012, 06_13_2013_QC_31736
View Hint #1
Worksheet Difficulty: Intermediate
Learning Objective: 05-05 Combined leverage takes
into account both the use of fixed assets and debt.
Problem 5-12 Break-even point and degree of
leverage [LO2, 5]
Learning Objective: 05-02 Break-even analysis
allows the firm to determine the magnitude of
operations necessary to avoid loss.
Problem 5-14 Nonlinear breakeven analysis [LO2]
International Data Systems information on revenue and costs is only relevant up to a sales volume of
122,000 units. After 122,000 units, the market becomes saturated and the price per unit falls from $12.00 to
$7.80. Also, there are cost overruns at a production volume of over 122,000 units, and variable cost per unit
goes up from $6.00 to $6.50. Fixed costs remain the same at $72,000.
(a) Compute operating income at 122,000 units. (Omit the “$” sign in your response.)
Operating income $
(b) Compute operating income at 222,000 units. (Omit the “$” sign in your response.)
Operating income $
rev: 02-16-2011
Worksheet Difficulty: Intermediate
Problem 5-14 Nonlinear breakeven analysis [LO2]
Learning Objective: 05-02 Break-even analysis
allows the firm to determine the magnitude of
operations necessary to avoid loss.
Problem 5-16 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 Able
Debt @ 9% $ 160,000 Debt @ 9% $ 320,000
Common stock, $10 par 320,000 Common stock, $10 par 160,000
Total $ 480,000 Total $ 480,000
Common shares 32,000 Common shares 16,000
(a) Compute earnings per share if earnings before interest and taxes are $32,000, $43,200, and $61,000
(assume a 20 percent tax rate). (Round your answers to 2 decimal places. Leave no cells blank –
be certain to enter “0” wherever required. Omit the “$” sign in your response.)
Cain Able
Earnings per share at $32,000 $ $
Earnings per share at $43,200 $ $
Earnings per share at $61,000 $ $
(b) What is the relationship between earnings per share and the level of EBIT?
1. Before tax return on assets is less than cost of Debt (Click to select)
2. Before tax return on assets equals cost of Debt (Click to select)
3. Before tax return on assets is greater than cost of Debt (Click to select)
(c) If the cost of debt went up to 11 percent and all other factors remained equal, what would be the break-
even level for EBIT? (Omit the “$” sign in your response.)
Break-even level $
View Hint #1
Worksheet Difficulty: Intermediate
Problem 5-16 Earnings per share and financial
leverage [LO4]
Learning Objective: 05-04 Financial leverage shows
how much debt the firm employs in its capital
structure.
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23.
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2.00 points
Problem 5-18 Combining operating and financial
leverage [LO5]
Sterling Optical and Royal Optical both make glass frames and each is able to generate earnings before
interest and taxes of $132,000.
The separate capital structures for Sterling and Royal are shown below:
Sterling Royal
Debt @ 12% $ 660,000 Debt @ 12% $ 220,000
Common stock, $5 par 440,000 Common stock, $5 par 880,000
Total $1,100,000 Total $1,100,000
Common shares 88,000 Common shares 176,000
(a) Compute earnings per share for both firms. Assume a 25 percent tax rate. (Round your answers to 2
decimal places. Omit the “$” sign in your response.)
Earnings per share
Sterling $
Royal $
(b) In part a, you should have gotten the same answer for both companies’ earnings per share. Assuming a
P/E ratio of 22 for each company, what would its stock price be? (Use rounded Earnings per share.
Round your answer to 2 decimal places. Omit the “$” sign in your response.)
Stock price $
(c) Now as part of your analysis, assume the P/E ratio would be 16 for the riskier company in terms of
heavy debt utilization in the capital structure and 24 for the less risky company. What would the stock
prices for the two firms be under these assumptions? (Note: Although interest rates also would likely be
different based on risk, we will hold them constant for ease of analysis.) (Use rounded Earnings per
share. Round your answers to 2 decimal places. Omit the “$” sign in your response.)
Stock price
Sterling $
Royal
$
Worksheet Difficulty: Advanced
Problem 5-18 Combining operating and financial
leverage [LO5]
Learning Objective: 05-04 Financial leverage shows
how much debt the firm employs in its capital
structure.
Problem 5-20 Combining operating and financial leverage [LO5]
Sinclair Manufacturing and Boswell Brothers Inc. are both involved in the production of brick for the
homebuilding industry. Their financial information is as follows:
Capital Structure
Sinclair Boswell
Debt @ 11% $ 1,260,000 0
Common stock, $10 per share 840,000 $ 2,100,000
Total $ 2,100,000 $ 2,100,000
Common shares 84,000 210,000
Operating Plan
Sales (61,000 units at $20 each) $ 1,220,000 $ 1,220,000
Less: Variable costs 976,000 610,000
($ 16 per unit) ($ 10 per unit)
Fixed costs 0 311,000
Earnings before interest and taxes (EBIT) $ 244,000 $ 299,000
(a) If you combine Sinclair’s capital structure with Boswell’s operating plan, what is the degree of combined
leverage? (Enter only numeric value rounded to 2 decimal places.)
Degree of combined leverage
(b) If you combine Boswell’s capital structure with Sinclair’s operating plan, what is the degree of combined
leverage? (Enter only numeric value.)
Degree of combined leverage
(d) In part b, if sales double, by what percentage will EPS increase? (Omit the “%” sign in your
response.)
EPS will increase by %
Worksheet Difficulty: Advanced
Problem 5-20 Combining operating and financial
leverage [LO5]
Learning Objective: 05-05 Combined leverage takes
into account both the use of fixed assets and debt.
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Problem 5-23 Leverage and sensitivity analysis
[LO6]
Dickinson Company has $11,840,000 in assets. Currently half of these assets are financed with long-term
debt at 9.2 percent and half with common stock having a par value of $8. Ms. Smith, vice-president of
finance, wishes to analyze two refinancing plans, one with more debt (D) and one with more equity (E). The
company earns a return on assets before interest and taxes of 9.2 percent. The tax rate is 45 percent.
Under Plan D, a $2,960,000 long-term bond would be sold at an interest rate of 11.2 percent and
370,000 shares of stock would be purchased in the market at $8 per share and retired.
Under Plan E, 370,000 shares of stock would be sold at $8 per share and the $2,960,000 in proceeds
would be used to reduce long-term debt.
(a) Compute the earnings per share for the current plan and the two new plans. (Round your answers to
2 decimal places. Omit the “$” sign in your response.)
Current Plan Plan D
Plan E
Earnings per share $ $ $
(b-1) Compute the earnings per share if return on assets fell to 4.60 percent. (Round your answers to 2
decimal places. Leave no cells blank – be certain to enter “0” wherever required. Negative
amounts should be indicated by a minus sign. Omit the “$” sign in your response.)
Current Plan Plan D Plan E
Earnings per share $ $ $
(b-2) Which plan would be most favorable if return on assets fell to 4.60 percent? Consider the current plan
and the two new plans.
Current Plan
Plan E
Plan D
(b-3) Compute the earnings per share if return on assets increased to 14.2 percent. (Round your answers
to 2 decimal places. Omit the “$” sign in your response.)
Current Plan Plan D Plan E
Earnings per share $ $ $
(b-4) Which plan would be most favorable if return on assets increased to 14.2 percent? Consider the
current plan and the two new plans.
Current Plan
Plan D
Plan E
(c-1) If the market price for common stock rose to $10 before the restructuring, compute the earnings per
share. Continue to assume that $2,960,000 in debt will be used to retire stock in Plan D and
$2,960,000 of new equity will be sold to retire debt in Plan E. Also assume that return on assets is
9.2 percent. (Round your answers to 2 decimal places. Omit the “$” sign in your response.)
Current Plan Plan D Plan E
Earnings per share $ $ $
(c-2) If the market price for common stock rose to $10 before the restructuring, which plan would then be
most attractive?
Current Plan
Plan D
Plan E
rev: 01_31_2013_QC_24744
View Hint #1
Worksheet Difficulty: Advanced
Problem 5-23 Leverage and sensitivity analysis
[LO6]
Learning Objective: 05-06 By increasing leverage,
the firm increases its profit potential, but also its risk
of failure.
Problem 5-25 Leverage and sensitivity analysis [LO6]
The Lopez-Portillo Company has $10.3 million in assets, 70 percent financed by debt and 30 percent
financed by common stock. The interest rate on the debt is 12 percent and the par value of the stock is $10
per share. President Lopez-Portillo is considering two financing plans for an expansion to $16.5 million in
assets.
Under Plan A, the debt-to-total-assets ratio will be maintained, but new debt will cost a whopping 14
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26.
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percent! Under Plan B, only new common stock at $10 per share will be issued. The tax rate is 40 percent.
(a) If EBIT is 13 percent on total assets, compute earnings per share (EPS) before the expansion and under
the two alternatives. (Round your answers to 2 decimal places. Omit the “$” sign in your
response.)
Earnings per share
Current $
Plan A $
Plan B $
(b) What is the degree of financial leverage under each of the three plans? (Enter only numeric values
rounded to 2 decimal places.)
Degree of
financial leverage
Current
Plan A
Plan B
(c) If stock could be sold at $20 per share due to increased expectations for the firm’s sales and earnings,
what impact would this have on earnings per share for the two expansion alternatives? Compute
earnings per share for each.(Round your answers to 2 decimal places. Omit the “$” sign in your
response.)
Earnings per share
Plan A $
Plan B $
rev: 01_19_2013
Worksheet Difficulty: Advanced
Problem 5-25 Leverage and sensitivity analysis
[LO6]
Learning Objective: 05-06 By increasing leverage,
the firm increases its profit potential, but also its risk
of failure.
Problem 5-27 Expansion, break-even analysis, and
leverage [LO2, 3, 4]
Delsing Canning Company is considering an expansion of its facilities. Its current income statement is as
follows:
Sales $ 6,400,000
Less: Variable expense (50% of sales) 3,200,000
Fixed expense 1,940,000
Earnings before interest and taxes (EBIT) 1,260,000
Interest (10% cost) 480,000
Earnings before taxes (EBT) 780,000
Tax (40%) 312,000
Earnings after taxes (EAT) $ 468,000
Shares of common stock 340,000
Earnings per share $ 1.38
The company is currently financed with 50 percent debt and 50 percent equity (common stock, par value
of $10). In order to expand the facilities, Mr. Delsing estimates a need for $3.4 million in additional
financing. His investment banker has laid out three plans for him to consider:
1.Sell $3.4 million of debt at 10 percent.
2.Sell $3.4 million of common stock at $20 per share.
3.Sell $1.70 million of debt at 9 percent and $1.70 million of common stock at $25 per share.
Variable costs are expected to stay at 50 percent of sales, while fixed expenses will increase to
$2,440,000 per year. Delsing is not sure how much this expansion will add to sales, but he estimates that
sales will rise by $1.70 million per year for the next five years.
Delsing is interested in a thorough analysis of his expansion plans and methods of financing.
(a) The break-even point for operating expenses before and after expansion. (Enter your answers in
dollars not in millions. Omit the “$” sign in your response.)
Break-even point
Before expansion $
After expansion
$
(b) The degree of operating leverage before and after expansion. Assume sales of $6.4 million before
expansion and $7.4 million after expansion. (Enter only numeric values rounded to 2 decimal
places.)
Degree of
operating leverage
Before expansion
After expansion
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(c-1) The degree of financial leverage before expansion. (Enter only numeric value rounded to 2
decimal places.)
Degree of financial leverage
(c-2) The degree of financial leverage for all three methods after expansion. Assume sales of $7.4 million for
this question. (Round your answers to 2 decimal places.)
Degree of
financial leverage
100% Debt
100% Equity
50% Debt & 50% Equity
(d) Compute EPS under all three methods of financing the expansion at $7.4 million in sales (first year)
and $10.3 million in sales (last year). (Round your answers to 2 decimal places. Omit the “$”
sign in your response.)
Earnings per share First year Last year
100% Debt $ $
100% Equity
50% Debt & 50% Equity
Worksheet Difficulty: Advanced
Learning Objective: 05-03 Operating leverage
indicates the extent fixed assets (plant and
equipment) are utilized by the firm.
Problem 5-27 Expansion, break-even analysis, and
leverage [LO2, 3, 4]
Learning Objective: 05-02 Break-even analysis
allows the firm to determine the magnitude of
operations necessary to avoid loss.
Learning Objective: 05-04 Financial leverage shows
how much debt the firm employs in its capital
structure.
