Question 1: McFrugal, Inc. has expected sales of $20 million. Fixed operating costs are $2.5 million, and the variable cost ratio is 65 percent. McFrugal has outstanding a $12 million, 8 percent bank loan. The firm also has outstanding 1 million shares of common stock ($1 par value). McFrugal's tax rate is 40 percent.
a. What is McFrugal's degree of operating leverage at a sales level of $20 million?
b. What is McFrugal's current degree of financial leverage?
c. Forecast McFrugal's EPS if sales drop to $15 million.
Question 2: East Publishing Company is doing an analysis of a proposed new finance textbook.
Using the following data, answer (a) through (d).
Fixed Costs per Edition:
Development (reviews, class testing, and so on) $18,000
Copyediting 5,000
Selling and promotion 7,000
Typesetting 40,000
Total $70,000
Variable Costs per Copy:
Printing and binding $4.20
Administrative costs 1.60
Salespeople's commission (2% of selling price) 0.60
Author's royalties (12% of selling price) 3.60
Bookstore discounts (20% of selling price) 6.00
Total $16.00
Projected Selling Price $30.00
The company's marginal tax rate is 40 percent.
a. Determine the company's breakeven volume for this book:
i. In units.
ii. In dollar sales.
b. Develop a breakeven chart for the textbook.
c. Determine the number of copies East must sell in order to earn an (operating) profit of $21,000 on this book.
d. Suppose East feels that $30.00 is too high a price to charge for the new finance textbook. It has examined the competitive market and determined that $24.00 would be a better selling price. What would the breakeven volume be at this new selling price?
Question 3: Rodney Rogers, a recent business school graduate, plans to open a wholesale dairy products firm. The business will be completely financed with equity. Rogers expects first year sales to total $5,500,000. He desires to earn a target pretax profit of $1,000,000 during his first year of operation. Variable costs are 40 percent of sales.
a. How large can Rogers' fixed operating costs be if he is to meet his profit target?
b. What is Rogers' breakeven level of sales at the level of fixed operating costs determined in (a)?