Question 1: Assuming that all other factors remain unchanged, determine how a firm's breakeven point is affected by each of the following:
a. The firm finds it necessary to reduce the price per unit because of competitive conditions in the market.
b. The firm's direct labor costs increase as a result of a new labor contract.
c. The Occupational Safety and Health Administration requires the firm to install new ventilating equipment in its plant. (Assume that this action has no effect on worker productivity.)
Question 2: Albatross Airline's fixed operating costs are $5.8 million, and its variable cost ratio is 0.20. The firm has $2 million in bonds outstanding with a coupon interest rate of 8 percent. Albatross has 30,000 shares of preferred stock outstanding, which pays a $2 annual dividend. There are 100,000 shares of common stock outstanding. Revenues for the firm are $8 million, and the firm is in the 40 percent corporate income tax bracket.
a. Compute Albatross' degree of operating leverage.
b. Compute its degree of financial leverage.
c. Compute its degree of combined leverage and interpret this value.
Question 3: A firm has sales of $10 million, variable costs of $5 million, EBIT of $2 million, and a degree of combined leverage of 3.0.
a. If the firm has no preferred stock, what are its annual interest charges?
b. If the firm wishes to lower its degree of combined leverage to 2.5 by reducing interest charges, what will be the new level of annual interest charges?
Question 4: Fastron, Inc. expects sales of silicon chips to be $60 million this year. Because this is a very capital-intensive business, fixed operating costs are $20 million. The variable cost ratio is 40 percent. The firm's debt obligations consist of a $4 million, 10 percent bank loan and a $20 million bond issue with an 11 percent coupon rate. Fastron has 1 million shares of common stock outstanding, and its marginal tax rate is 40 percent.
a. Compute Fastron's degree of operating leverage.
b. Compute Fastron's degree of financial leverage.
c. Compute Fastron's degree of combined leverage.
d. Compute Fastron's EPS if sales decline by 5 percent.