Exam 14: Capital Structure Management in Practice

When fixed capital costs are incurred by the firm, a change in is magnified into a larger change in earnings per share.

Leigh Fibers expects its operating income over the coming year to equal $2.5 million with a standard deviation of $800,000.Leigh must pay interest charges of $1.2 million next year and preferred dividends of $300,000.Leigh's marginal tax rate is 35%.What is the probability that Leigh will have negative EPS next year if its operating income is expected to be normally distributed? (Problem requires normal distribution table.)

Higgins currently has 2 million shares of common stock outstanding that are selling for $32 per share.Higgins also has a $20 million mortgage bond outstanding that has an 11 percent coupon rate.Higgins is considering two alternatives to financing a major expansion.Plan A is to sell $10 million of additional long-term debt with a 12.5 percent coupon.Plan B is to sell 200,000 shares of common stock at $30 per share and $4 million in long-term debt with an 11.25 percent coupon.What is the EBIT indifference level between these two alternatives? Assume the marginal tax rate is 40 percent.

Explain the difference between short-run costs and long-run costs.

Raw material and direct labor costs are examples of