Quantitative Problems

1. Suppose QuickCharge Corporation manufactures phone chargers. They sell their chargers for $20. Their fixed operating costs are $100,000 and their variable operating costs are $10 per charger. Currently they are selling 30,000 chargers per year. A. What is QuickCharge’s EBIT (earnings before interest and taxes) at current sales of 30,000? B. What is QuickCharge’s breakeven point? C. Calculate the EBIT if QuickCharge’s sales increase 50% to 45,000 chargers. What is the percent of change in EBIT under this increase in sales? Also, calculate the EBIT if the company's sales decrease 50% to 15,000 chargers. What is the percent of change in EBIT under this decrease in sales? D. What is QuickCharge’s degree of operating leverage? Based on your computation, what does its operating leverage say about QuickCharge’s business risk? 2. The StayDry Umbrella Corporation will have an EBIT of $100,000 if there is a normal amount of rain this year. But if there is a drought, they will have an EBIT of only $50,000. The interest rate on debt is 10%, and the tax rate is 35%. The company does not pay any preferred dividends. A. If StayDry has zero debt and 50,000 outstanding shares, what will its EPS (earnings per share) be if there is normal rain? What will its EPS be if there is a drought? What is its DFL (degree of financial leverage)? B. Now suppose StayDry has decided to take on $300,000 in debt and has used these funds to buy back half of the outstanding shares so now there are only 25,000 outstanding shares. What is the new EPS and DFL for both normal rain and drought? C. Based on your answers to a) and b) above, what are the trade-offs management has to make between zero debt or $300,000 in debt? What are the benefits and disadvantages of taking on this debt?

Sample Solution

A. EBIT:

Sales = 30,000 chargers * $20/charger = $600,000 Variable costs = 30,000 chargers * $10/charger = $300,000 EBIT = Sales - Variable costs - Fixed costs EBIT = $600,000 - $300,000 - $100,000 = $200,000

B. Breakeven Point:

Breakeven point = Fixed costs / (Price - Variable cost) Breakeven point = $100,000 / ($20 - $10) = 10,000 chargers

C. EBIT changes with different sales:

50% increase in sales (45,000 chargers):
- New sales = 45,000 chargers * $20/charger = $900,000
- New EBIT = $900,000 - $450,000 - $100,000 = $350,000

Full Answer Section

- Percent change in EBIT = ($350,000 - $200,000) / $200,000 * 100% = 75% increase
50% decrease in sales (15,000 chargers):
- New sales = 15,000 chargers * $20/charger = $300,000
- New EBIT = $300,000 - $150,000 - $100,000 = $50,000
- Percent change in EBIT = ($50,000 - $200,000) / $200,000 * 100% = 75% decrease

D. Degree of Operating Leverage (DOL):

DOL = (Contribution margin / Sales) / (EBIT / Sales) Contribution margin = Price - Variable cost = $20 - $10 = $10 DOL = ($10 / $600,000) / ($200,000 / $600,000) = 1.5

Interpretation of DOL: QuickCharge has a DOL of 1.5, meaning that a 1% change in sales will lead to a 1.5% change in EBIT. This indicates a high degree of operating leverage, making the company more sensitive to fluctuations in sales. This means that even small changes in sales can have a significant impact on the company's profitability, increasing the business risk.

StayDry Umbrella Corporation Calculations:

A. EPS and DFL without debt:

Normal rain EPS = EBIT / Outstanding shares = $100,000 / 50,000 shares = $2.00/share
Drought EPS = $50,000 / 50,000 shares = $1.00/share
DFL = (EBIT change from 1% sales change) / (EPS change from 1% sales change)
DFL = [(1%*EBIT)/EBIT] / [(1%*EPS)/EPS] = EBIT / EPS
DFL (normal rain) = $100,000 / $2.00/share = 50
DFL (drought) = $50,000 / $1.00/share = 50

B. EPS and DFL with debt:

Interest expense = $300,000 * 10% = $30,000
New EBIT (normal rain) = $100,000 - $30,000 = $70,000
New EBIT (drought) = $50,000 - $30,000 = $20,000
New EPS (normal rain) = $70,000 / 25,000 shares = $2.80/share
New EPS (drought) = $20,000 / 25,000 shares = $0.80/share
New DFL (normal rain) = $70,000 / $2.80/share = 25

We are here to help

We have crazy offers

It’s quick and easy to place an order. We have an efficient customer service that works 24/7 to assist you.It’s quick and easy to place an order. We have an efficient customer service that works 24/7 to assist you.

We are here and ready to help

Order Now