Exam 14: Capital Structure Management in Practice

Twin City Printing is considering two financial alternatives for financing a major expansion program.Under either alternative EBIT is expected to be $15.6 million.Currently the firm's capital structure consists of 4 million shares of common stock and $35 million in 11% long-term bonds.Under the debt financing alternative $10 million in 12% long­ term bonds will be sold and under the equity financing alternative the firm would sell 500,000 shares of common stock.The PIE under the debt alternative would be 15 and the PIE under the equity alternative would be 16.The firm's marginal tax rate is 40%.Which alternative would produce the higher stock price?

A DFL (degree of financial leverage) of 3.0 indicates that a 27% increase in EPS is the result of a increase in EBIT.

When fixed operating costs are incurred by the firm, a change in is magnified into a relatively larger change in earnings before interest and taxes.

The degree of combined leverage is equal to the multiplied by the .

Centex, a producer of telephone systems for small businesses, has current sales of$43 million and variable operating costs of$27.95 million.Centex expects to increase sales in the coming year by 15% while keeping fixed operating costs constant at $9.1 million.What is the DOL for Centex?

Illinois Tool Company's (ITC) fixed operating costs are $1,260,000 and its variable cost ratio (i.e., variable costs as a fraction of sales) is 0.70.The firm has $3,000,000 in bonds outstanding at an interest rate of 8 percent.ITC has 30,000 shares of $5 preferred stock and 150,000 shares of common stock outstanding.ITC is in the 50 percent corporate income tax bracket.Forecasted sales for next year are $9 million.What is ITC's degree of financial leverage at an EBIT level of $1,440,000?

Onex expects to have an EBIT of $240,000 with a standard deviation of $90,000.The distribution of operating income is approximately normal.What is the probability that Onex will have an EBIT that is below $0?

ASG expects next year's operating income (EBIT) to equal $22 million, with a standard deviation of $16 million.The coefficient of variation of operating income is equal to 0.73.Interest expenses will be $9 million next year and debt retirement will require a principal payment of $2.5 million.ASG's marginal tax rate is 40%.If EBIT is normally distributed, what is the probability that ASG will have a negative EPS next year?

Fanny Nanny Weight Monitors, Inc.is considering two financial alternatives for financing a major expansion program.Under either alternative, EBIT is expected to be $12.5million.Currently the firm's capital structure consists of 2 million shares of common stock and $15 million in 6% long-term bonds.Under the debt financing alternative $8 million in 4% long-term bonds will be sold and under the equity financing alternative the firm would sell 150,000 shares of common stock.The P/E under the debt alternative would be 21 and the P/E under the equity alternative would be 22.The firm's marginal tax rate is 40%.Which alternative would produce the higher stock price?

TCA Cable has fixed operating cost of $2.6 million, and its variable cost ratio is 0.30.TCA has $4.0 in bonds outstanding with a coupon interest rate of 12%.TCA has 1.0 million common shares and 1,000,000 shares of $1.75 preferred stock outstanding.Total revenues for TCA Cable are $14.2 million.If TCA has a marginal tax rate of 40%, what is its degree of combined leverage?

Knight Moves is considering two alternative financing plans.The firm is expected to operate at the $75 million EBlT level.Under Plan D (debt financing) EPS is expected to be $2.25, and under Plan E (equity financing) EPS is expected to be $1.82.If the market is expected to assign a PIE ratio of 12 to the debt plan and 15 to the equity plan, which plan should Knight pursue?

Financial leverage causes a firm's to change at a rate greater than the change in .

What type of security is used to purchase a target company in a leveraged buy-out?

What is the degree of operating leverage for Flippin' Out Company, a maker of scuba flippers, if the firm sells its finished product for $50 per unit with variable costs per unit of $15? The company has fixed operating costs of $2,000,000 and sells 200,000 units (the answer is rounded).

Magnificent Manes Hair Salons is forecasting a 17% increase in sales.What would be its degree of operating leverage if it anticipates that its EBIT will go from $150,000 to $175,000 during the same time frame?

A firm is said to be if it is unable to meet its current obligations.

To balance the operating and financial risks that are so variable for a multinational company, Nestle allows its foreign operating subsidiaries operational flexibility and follows a financing strategy.

There are three categories of costs: fixed costs, variable costs and semi-variable costs.Which of the following is a semi-variable cost?

Borkstran has sales of $7.8 million, a variable cost ratio of 0.6, EBIT of $1.1 million, and a degree of combined leverage of 3.4.What is Borkstran's degree of financial leverage?

A firm that employs a relatively large proportion of debt and preferred stock in its capital structure will have a relatively degree of financial leverage.