Problem:
Jim Wilson is considering the possibility of opening his own machine shop, He expects first-year sales to be $600,000, and he feels that his variable costs will be approximately 50% of sales. His fixed costs in the first year will be $250,000.
Jim is considering two ways of financing the firm: a) 60% equity financing and 40% debt at 14%, or b) 100% equity financing. He can sell common stock to his relatives for $10 per share. Either way, he will need to raise $800,000.
a) compute his break-even point in dollars.
b) calculate the degree of operating leverage at the expected first-year sales volume.
c) calculate the degree of Financial Leverage and the Degree of Combined Leverage under each possible financing plans.
d) Explain the implications of the answers if the machine shop business is highly cyclical.