302950

Question 1

Finn Products, a start-up company, wants to use cost-based pricing for its only product, a unique new video game. Finn expects to sell 10,000 units in the upcoming year. Variable costs will be $65 per unit and annual fixed operating costs (including depreciation) amount to $80,000. Finn’s balance sheet is as follows:

Assets Liabilities and Equity
Current assets $100,000 Accounts payable $ 25,000
Plant and equipment 425,000 Debt 200,000
Equity 300,000
If Finn wants to earn a 20% return on equity, at what price should it sell the new product?

$78.60

$79.00

$81.00

$75.00

Answer 1

$79.00

Return on equity (ROE) = Net Income ÷ Equity
Net income = Equity × ROE = $300,000 × 20% = $60,000
Net Income = (Price - Variable costs) × Number of units - Fixed costs
Price = (Net income + Fixed costs + (Variable costs × Number of units)) ÷ Number of units = [$60,000 + $80,000 + ($65 × 10,000)] ÷ 10,000 = $790,000 ÷ 10,000 = $79.00

Question 2

Operating Costs

Answer 2

Operating costs are costs directly attributable to the operations of business activities.

Question 3

Variable Cost

Answer 3

A variable cost is a cost that varies with changes in the level of production (i.e., total cost increases with increases in production volume). Cost per unit is constant over the relevant range of production.

Question 4

2164.04

Answer 4

Return on equity (ROE)

The return on equity ratio measures the return to common stockholders. The ratio calculates how many dollars were earned for each dollar of common equity. When comparing this ratio with ROA (return on assets), the investment of the creditors is removed. This ratio is affected by the net income available to the stockholders (Net income – Preferred dividends), the profit margin available to the stockholders, the asset turnover, and the extent to which assets are financed by common stockholders. The method of financing used (debt vs. equity) has a major effect on this ratio.

Return on equity = Net income − Preferred dividends
Average common equity

Or, using the DuPont equation:

ROE = Net income − Preferred dividends × Sales × Average assets
Sales Average assets Average stockholders’ equity

The denominator consists of the average of the total equity less preferred shares and minority interest. One of the major problems with this ratio is that the historical issue price is used as opposed to the current market value.
The common stockholders’ leverage ratio (Average assets/Average stockholders’ equity used above) measures the portion of assets that are financed through common equity (also called the equity multiplier). The larger this ratio, the greater the financial leverage will be. Various organizations within an industry will have potentially dramatic differences in ROE resulting from financing decisions—debt vs. equity. If ROA is greater than the cost of borrowing, then ROE will be higher than ROA due to the impact of financial leverage.
Calculation using data from the Sample Company for 20X2 (section 2160.01):

Net income − Preferred dividends = Return on equity
Average common equity

    $75,000 − $15,000         = 22%
($300,000 + $250,000) ÷ 2