Exam 14: Capital Structure Management in Practice

Midwest Can Company is considering opening a new plant in St. Louis that is expected to produce an average EBIT of $3 million per year. To finance this new plant, Midwest is considering two financing plans. The first plan is to sell 600,000 shares of common stock at $15 each. The second plan is to sell 200,000 shares of common stock at $15 each and $6 million of 13 percent long-term debt. If Midwest has a marginal tax rate of 40 percent, what is the EBIT-EPS indifference point for this plant?

Explain the difference between short-run costs and long-run costs.

Fanny Nanny Weight Monitors, Inc. is considering two financial alternatives for financing a major expansion program. Under either alternative, EBIT is expected to be $12.5million. Currently the firm's capital structure consists of 2 million shares of common stock and $15 million in 6% long-term bonds. Under the debt financing alternative $8 million in 4% long-term bonds will be sold and under the equity financing alternative the firm would sell 150,000 shares of common stock. The P/E under the debt alternative would be 21 and the P/E under the equity alternative would be 22. The firm's marginal tax rate is 40%. Which alternative would produce the higher stock price?

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 financial leverage.

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

Magnificent Manes Hair Salons is forecasting a 17% increase in sales. What would be its degree of operating leverage if it anticipates that its EBIT will go from $150,000 to $175,000 during the same time frame?

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

The Ames Company has an expected EBIT of $16 million with a standard deviation of $8 million. The indifference point between a debt financing alternative and a common stock financing alternative was computed to be $12 million. Determine the probability that the equity financing alternative will be superior to the debt financing alternative (i.e., have a higher EPS). (Problem requires normal distribution table.)

What type of security is used to purchase a target company in a leveraged buy-out?

In considering EBIT-EPS analysis, which of the following statements is/are correct?

A negative DOL indicates the percentage ____ in operating losses that occurs as the result of a 1% increase in output.

Weis Products has fixed operating costs of $20 million and a variable cost ratio of 0.55. Weis has 4 million common shares outstanding and a marginal tax rate of 45%. What is Weis's degree of operating leverage at an expected sales level of $150 million.

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.

Centex, a producer of telephone systems for small businesses, has current sales of $43 million and variable operating costs of $27.95 million. Centex expects to increase sales in the coming year by 15% while keeping fixed operating costs constant at $9.1 million. What is the DOL for Centex?

The degree of combined leverage is equal to the degree of operating leverage ____ the degree of financial leverage.

Raw material and direct labor costs are examples of

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

Why does a firm use operating and financial leverage? In what ways does it help the firm, in what ways does it hurt the firm?

If a firm sees its EPS increase 27% on a 12% increase in sales, what is the firm's DOL. During the same period the firm saw its EBIT increase only 8%.

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 percent. ITC has 30,000 shares of $5 preferred stock and 150,000 shares of common stock outstanding. ITC is in the 50 percent 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?