Exam 17: Capital Structure Management in Practice

Given the following financial data for Cosmos, compute the firm's degree of financial leverage. Last Year This Year Sales \ 780,000 \ 874,000 Fixed costs 195,000 218,500 Variable costs 460,200 524,400 EBIT 124,800 131,100 Interest 46,800 52,400 EPS \ 0.42 \ 0.51

Illinois Tool Company's (ITC) fixed operating costs are $1,260,000, and its variable cost ratio (i.e., variable costs as a fraction of sales) is 0.70. The firm has $3,000,000 in bonds outstanding at an interest rate of 8%. ITC has 30,000 shares of $5 preferred stock and 150,000 shares of common stock outstanding. ITC is in the 50% corporate income tax bracket. Forecasted sales for next year are $9 million. What is ITC's degree of operating leverage at a sales level of $9 million?

Higgins currently has 2 million shares of common stock outstanding that are selling for $32 per share. Higgins also has a $20 million mortgage bond outstanding that has an 11% coupon rate. Higgins is considering two alternatives to financing a major expansion. Plan A is to sell $10 million of additional long-term debt with a 12.5% coupon. Plan B is to sell 200,000 shares of common stock at $30 per share and $4 million in long-term debt with an 11.25% coupon. What is the EBIT indifference level between these two alternatives? Assume the marginal tax rate is 40%.

A change in EBIT is magnified into a larger change in EPS. This means that financial leverage is using ____ as its fulcrum.

Knight Moves is considering two alternative financing plans. The firm is expected to operate at the $75 million EBIT level. Under Plan D (debt financing) EPS is expected to be $2.25, and under Plan E (equity financing) EPS is expected to be $1.82. If the market is expected to assign a P/E ratio of 12 to the debt plan and 15 to the equity plan, which plan should Knight pursue?

Onex expects to have an EBIT of $240,000 with a standard deviation of $90,000. The distribution of operating income is approximately normal. What is the probability that Onex will have an EBIT below $0? (Problem requires a normal distribution table.)

Kermit's Hardware's (KH) fixed operating costs are $20.8 million, and its variable cost ratio is 0.30. The firm has $10 million in bonds outstanding with a coupon interest rate of 9%. KH has 200,000 shares of common stock outstanding. The firm has revenues of $32.2 million, and its marginal tax rate is 40%. Compute KH's degree of operating leverage.

Crown Data(CD) has a current capital structure that consists of $120 million in common equity (15 million shares) and $80 million in long-term debt with an average interest rate of 11%. CD is considering an expansion project that will cost $22 million. The project will be financed either by issuing long-term debt at a cost of 12.5%, or the sale of new common stock at $35 per share. The firm's marginal tax rate is 40%. What is the EBIT indifference point between the two financing options?

The percentage change in a firm's EBIT that results in a 1% change in sales or output is known as the degree of ____.

What would be the degree of financial leverage for Foggy Futures Weather Forecasters if the company has earnings before interest and taxes of $750,000, has a 4.5% loan on $1,000,000, and is in the 38% tax bracket? The firm does not have any preferred stock outstanding.

The degree of financial leverage is defined as the percentage change in ____.

Kermit's Hardware's (KH) fixed operating costs are $20.8 million, and its variable cost ratio is 0.30. The firm has $10 million in bonds outstanding with a coupon interest rate of 9%. KH has 200,000 shares of common stock outstanding. The firm has revenues of $32.2 million, and its marginal tax rate is 40%. Compute KH's degree of combined leverage.

When fixed operating costs are incurred by the firm, a change in ____ is magnified into a relatively larger change in earnings before interest and taxes.

In what way does management's willingness to assume risk impact the firm?

To balance the operating and financial risks that are so variable for a multinational company, Nestlé allows its foreign operating subsidiaries ____ operational flexibility and follows a ____ financing strategy.

The Albany Corporation has a present capital structure consisting of common stock ($200 million, 10 million shares) and debt ($150 million, 8%). The company is planning a major expansion and is undecided between two financing plans. Plan A: Equity financing. Under this plan, an additional 2.5 million shares of common stock will be sold at $15 each. Plan B: Debt financing. Under this plan, $37.5 million of 10% long-term debt will be sold. ? What is the EBIT-EPS indifference point? Assume a 40 percent marginal tax rate.

Borkstran has sales of $7.8 million, a variable cost ratio of 0.6, EBIT of $1.1 million, and a degree of combined leverage of 3.4. What is Borkstran's degree of financial leverage?

A firm that has a 2.5 DOL (degree of operating leverage) would find that an 8% increase in EBIT would result from a ____ increase in sales.

Cash insolvency analysis evaluates the adequacy of a firm's cash position in a ____.

Archive Storage earned $3.20 a share on sales of $13.6 million. Archive has determined that its degree of operating leverage is 1.87 and its degree of financial leverage is 2.91. If sales are expected to increase 15%, what will be the EPS forecast?