Problem 1: The XYZ Company manufactures clocks. The company's income statement for 2004 is as follows:
XYZ Company
Income Statement
For the Year Ended December 31, 2004
|
Sales (10,000 clocks @ $40 each)...................
|
$400,000
|
|
Less: Variable costs (10,000 clocks at $20)..
|
200,000
|
|
Fixed costs........................................................
|
150,000
|
|
|
|
|
Earnings before interest and taxes (EBIT)......
|
50,000
|
|
Interest expense..................................................
|
10,000
|
|
|
|
|
Earnings before taxes (EBT).............................
|
40,000
|
|
Income tax expense (40%).................................
|
16,000
|
|
Earnings after taxes (EAT).................................
|
$ 24,000
|
Given this income statement, compute the following:
a. Degree of operating leverage.
b. Degree of financial leverage.
c. Degree of combined leverage.
d. Break-even point in units (number of clocks).
Problem 2.
Blue Corp and Red Corp are competitors in the widget supplies business. The separate capital structures for Blue and Red are presented below.
|
Blue
|
Red
|
|
Debt @ 10%..................$ 100,000
|
Debt @ 10%...................... $200,000
|
|
Common stock, $10 par.. 200,000
|
Common stock, $10 par.. 100,000
|
|
Total.........................$300,000
|
Total................................. $300,000
|
|
Common shares.............. 20,000
|
Common shares.............. 10,000
|
a. Compute earnings per share if earnings before interest and taxes (EBIT) are $20,000, $30,000, and $60,000 (assume a 25 percent tax rate).
b. Explain the relationship between earnings per share and the level of EBIT.
c. If the cost of debt went up to 12 percent and all other factors remained equal, what would be point of indifference for EBIT for the two capital structures?