Chapter 4: Financing Decisions - Leverage and Capital Structure Flashcards
One of the most important firm decisions is how much __________ a firm should employ
Leverage
Costs that does not change
Fixed Costs
Costs that does change with the level of operation/volume of production.
Variable Costs
Leverage is the degree or level in which a company must incur __________
Fixed Costs
The extent to which the firm gets cash resources from borrowing as opposed to additional shares of equity.
Financial Leverage
T/F
The greater the debt equity, the more lesser leveraged the firm is because debt legally obligates the firm to pay interest.
False
The greater the debt equity, the more “higher” leveraged the firm is because debt legally obligates the firm to pay interest.
Option A: Older Machine
- Rental: 10,000 / year
- Variable Cost: 30 per unit
- Selling Price: 50 per unit
- can produce 6,000 units
Option B: New machines
- Rental: 15,000
- Variable Cost: 25 per unit
- Selling Price: 50 per unit
- can produce 10,000 units
Compute:
Gross profit/margin
Found in printed paper
The extent to which a firm commits itself to high levels of fixed cost other than the interest rate.
Operating Leverage
Option A: Older Machine
- Rental: 10,000 / year
- Variable Cost: 30 per unit
- Selling Price: 50 per unit
- can produce 6,000 units
Option B: New machines
- Rental: 15,000
- Variable Cost: 25 per unit
- Selling Price: 50 per unit
- can produce 10,000 units
Compute:
Break Even-point
Found in Printed Paper
Acts as a lever to magnify the influence of fluctuations.
Financial Leverage
is magnified on the earnings per share by operation of leverage.
Earnings before interest and Taxes (EBIT)
The greater the degree of leverage, the wider the variation in EPS given any change in EBIT.
Financial Leverage
ABC Company is capitalized with P1M divided in 1,000 common shares of P1,000 each. The management wishes to raise another P1M to finance a major program of expansion through one of our possible financing plans. The Management may finance the company with:
a.) All Common Stock
b.) P500K in common stock and P500K in debt at 10% interest, or
c.) all debt at 6% interest
d.) P500K in common stock and P500K in preferred stock with 10% per dividend.
The company’s existing earnings before interest and taxes (EBIT) amounted to P120,000. Corporation tax is assumed to be 32 percent.
Compute:
Option A & B
Found in printed paper
ABC Company is capitalized with P1M divided in 1,000 common shares of P1,000 each. The management wishes to raise another P1M to finance a major program of expansion through one of our possible financing plans. The Management may finance the company with:
a.) All Common Stock
b.) P500K in common stock and P500K in debt at 10% interest, or
c.) all debt at 6% interest
d.) P500K in common stock and P500K in preferred stock with 10% per dividend.
The company’s existing earnings before interest and taxes (EBIT) amounted to P120,000. Corporation tax is assumed to be 32 percent.
Compute:
Option C
Found in printed paper
ABC Company is capitalized with P1M divided in 1,000 common shares of P1,000 each. The management wishes to raise another P1M to finance a major program of expansion through one of our possible financing plans. The Management may finance the company with:
a.) All Common Stock
b.) P500K in common stock and P500K in debt at 10% interest, or
c.) all debt at 6% interest
d.) P500K in common stock and P500K in preferred stock with 10% per dividend.
The company’s existing earnings before interest and taxes (EBIT) amounted to P120,000. Corporation tax is assumed to be 32 percent.
Compute:
Option D
Found in printed paper
ABC Company is capitalized with P1M divided in 1,000 common shares of P1,000 each. The management wishes to raise another P1M to finance a major program of expansion through one of our possible financing plans. The Management may finance the company with:
a.) All Common Stock
b.) P500K in common stock and P500K in debt at 10% interest, or
c.) all debt at 6% interest
d.) P500K in common stock and P500K in preferred stock with 10% per dividend.
The company’s existing earnings before interest and taxes (EBIT) amounted to P120,000. Corporation tax is assumed to be 32 percent.
Compute:
Reccomendation
Found in the Printed Paper
Sunlight Corporation is capitalized with P100M worth of common stocks at P1,000 per share. It needs to raise additional P50M for its branch expansion in Mindanao with common shares at P1,000 per share. EBIT is at P15M and tax rate is 30%. It considers 4 options:
Option A: All debt at 8%
Option B: All common stock
Option C: 50% debt at 8% interest rate and 50% common
Option D: 50% common and the remaining half is 15% prefeered Stock
Compute
EPS in Option A
Found in Printed Paper
Sunlight Corporation is capitalized with P100M worth of common stocks at P1,000 per share. It needs to raise additional P50M for its branch expansion in Mindanao with common shares at P1,000 per share. EBIT is at P15M and tax rate is 30%. It considers 4 options:
Option A: All debt at 8%
Option B: All common stock
Option C: 50% debt at 8% interest rate and 50% common
Option D: 50% common and the remaining half is 15% prefeered Stock
Compute
EPS in Option B
Found in Printed Paper
Sunlight Corporation is capitalized with P100M worth of common stocks at P1,000 per share. It needs to raise additional P50M for its branch expansion in Mindanao with common shares at P1,000 per share. EBIT is at P15M and tax rate is 30%. It considers 4 options:
Option A: All debt at 8%
Option B: All common stock
Option C: 50% debt at 8% interest rate and 50% common
Option D: 50% common and the remaining half is 15% prefeered Stock
Compute
EPS in Option C
Found in Printed Paper
Sunlight Corporation is capitalized with P100M worth of common stocks at P1,000 per share. It needs to raise additional P50M for its branch expansion in Mindanao with common shares at P1,000 per share. EBIT is at P15M and tax rate is 30%. It considers 4 options:
Option A: All debt at 8%
Option B: All common stock
Option C: 50% debt at 8% interest rate and 50% common
Option D: 50% common and the remaining half is 15% prefeered Stock
Compute
EPS in Option D
Found in Printed Paper
Sunlight Corporation is capitalized with P100M worth of common stocks at P1,000 per share. It needs to raise additional P50M for its branch expansion in Mindanao with common shares at P1,000 per share. EBIT is at P15M and tax rate is 30%. It considers 4 options:
Option A: All debt at 8%
Option B: All common stock
Option C: 50% debt at 8% interest rate and 50% common
Option D: 50% common and the remaining half is 15% prefeered Stock
Compute
Give your recommendation
Found in Printed Paper
Formula of Break Even Point
BEP = FC / CM (SP - VC)
The format of Financial Leverage
Gross Sales
Less: CGS
Gross Profit
Less: Operating Expense
Earning before interest and taxes (EBIT)
Less: Interest Expense
Earning before tax
Less: Tax
Net Income
Format of Getting EPS
EBIT
Less: Interest Expense
Earnings before Tax
Less: Tax Expense
Earnings after tax
Less: Dividend payment to P/S
Earnings avail to C/Stockholders
No. of shares outstanding
Add: C/ shares
EPS
