Exam 12: Determining the Financing Mix

Balon Plastics,Inc.is financed entirely with 3 million shares of common stock selling for $20 a share.Capital of $4 million is needed for this year's capital budget.Additional funds can be raised with new stock (ignore dilution)or with 13 percent 10-year bonds.The firm's tax rate is 40 percent. a.Calculate the financing plan's EBIT indifference point. b.The expected level of EBIT is $10,320,000 with a standard deviation of $2,000,000.What is the probability that EBIT will be above the indifference point? c.Does the "indifference point" calculated in question (a)above truly represent a point where stockholders are indifferent between stock and debt financing? Explain your answer.

Which of the following would be considered a fixed cost in a manufacturing setting?

Jones Blanket Company sells blankets for $25 each.The variable cost of each blanket is $10.If fixed cost is $4,500,000 then the break-even point is 300,000 units.

All of the following are likely to result in the use of less debt in a company's capital structure EXCEPT

Operating leverage means financing a portion of a firm's earnings per share with debt.

Companies that sell basic necessities face the highest levels of business risk because consumers will price shop aggressively for items they purchase on a regular basis.

Operating leverage has to do with

Variable costs include all of the following EXCEPT

Capital structure is equal to financial structure minus current liabilities.

Financial structure includes long- and short-term sources of funds.

Rogue Tire Masters has fixed costs of $220,000.Tires sell for $95 each and have a unit variable cost of $45.What is Rogue's break-even point in units?

A corporation's debt capacity is the maximum proportion of debt that the corporation can include in its capital structure and still maintain its lowest composite cost of capital.

Stan's Cans,Inc.expects to earn $150,000 next year after taxes on sales of $2,200,000.Stan's manufactures only one size of garbage can.Stan sells his cans for $8 apiece and they have a variable cost of $2.40 apiece.Stan's tax rate is currently 34%. a.What are the firm's expected fixed costs for next year? b.What is the break-even point in units?

Business risk refers to the relative dispersion (variability)of a company's net income.

Balon Plastics,Inc.is trying to decide how best to finance a proposed $10,000,000 capital investment.Under Plan I,the project will be financed entirely with long-term 9 percent bonds.The firm currently has no debt or preferred stock.Under Plan II,common stock will be sold to net the firm $20 a share; presently,1,000,000 shares are outstanding.The corporate tax rate for Roberts is 40 percent. a.Calculate the indifference level of EBIT associated with the two financing plans. b.Prepare an EBIT-EPS analysis chart,showing the intersection of the two financing plan lines. c.Which financing plan would you expect to cause the greatest change in EPS relative to a change in EBIT? Why? d.If EBIT is expected to be $3.1 million,which plan will result in a higher EPS?

A CEO concerned about variability of earnings per share may try to offset high operating leverage with a capital structure that is mostly debt in order to take advantage of the interest tax shield.

Break-even analysis is a short-term concept because,in the long run,all costs are variable.

The Modigliani and Miller hypothesis suggests that capital structure doesn't matter.All of the following conditions need to be met for this hypothesis to be true EXCEPT

DXZ,Inc.currently produces one product which sells for $250 per unit.The company's fixed costs are $75,000 per year; variable costs are $205 per unit.A salesman has offered to sell the company a new piece of equipment which will increase fixed costs to $100,000.The salesman claims that the company's break-even point will not be altered if the company purchases this equipment.What will be the company's new variable cost per unit?

The three major components responsible for variation in a company's income stream are business risk,operating risk,and financial risk.