b)
1)
Case summary:
Company P is a regional pizza restaurant chain. The given details are as follows,
EBIT is $50 million,
Tax rate is 40%,
Risk-free rate of return is 6%,
Market risk premium is 6%,
Outstanding shares 10 million.
As of now company is financed with equity only, there is no debt. Now, the company wanted to raise capital by using some debt. When the company were to recapitalize, then debt would be issued, and funds received would be used as repurchase stock.
To discuss: Business risk and factors influence firm’s business risk.
2)
To discuss: Operating leverage and factors influencing operating leverage and calculate the operating leverage when fixed costs are $200, sale price is $15, and variable cost is $10.
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Intermediate Financial Management (MindTap Course List)
- What is operating leverage, and how does itaffect a firm’s business risk? Show the operating break-even point if a company has fixedcosts of $200, a sales price of $15, and variablecosts of $10.arrow_forwardWhat affects the firm’s operating break-even point? Several factors affect a firm’s operating break-even point. Based on the scenarios described in the following table, indicate whether these factors would increase, decrease, or leave unchanged a firm’s break-even quantity—assuming that only the listed factor changes and all other relevant factors remain constant. Increase Decrease No Change The product’s sales price increases. The amount of debt increases, causing the firm’s total interest expense to increase. The firm’s fixed costs increase. When fixed costs are high, a small decline in sales can lead to a decline in return on invested capital (ROI).arrow_forwardBy modifying the break-even equation, a company is able to determine the sales required to earn a ________________ profit. a.banker's b.working capital c.target d. contributionarrow_forward
- How many statements below about operating leverage are correct? 1. Operating leverage measures the sensitivity of a firm's operating income to changes in the firm's level of sales. 2. Automated operations results to greater operating leverage for the firm than mechanical operations. 3. An operațing leverage of 5 means that a firm's operating income will increase by P0.5 for every P1 increase in sales. 4. Operating leverage will decrease as the firm's margin of safety increases. 5. The higher the firm's operating leverage, the higher is its income potential but at the same time, the higher the risk of incurring loss. 1 2 4arrow_forwardYou observe that a firm?s profit margin is below the industry average, while its return on equity and debt ratio exceed the industry average. What can you conclude?arrow_forwardAnswer true or false. 1. According to the economic order quantity model, the total period cost would depend, among other things, on the size of each order.☐True☐False2. According to the economic order quantity model, there is no lead time for delivery of goods.☐True☐False3. Working capital is the capital of the company.☐True☐False4. Acquiring a fixed asset exclusively with long-term debt reduces net working capital.☐True☐False5. It is in the firm's interest to have a high cash balance at all times.☐True☐Falsearrow_forward
- Current Ratio. What effect would the following actions have on a firm's current ratio? Assume that net working capital is positive. a. Inventory is purchased. b. A supplier is paid. c. A short-term bank loan is repaid. d. A long-term debt is paid off early. e. A customer pays off a credit account. f. Inventory is sold at cost. g. Inventory is sold for a profit. LO 3.2arrow_forwardWhich of the following statements about operating leverage is false? a. Operating leverage measures how operating income will be affected by changes in sales b. The degree of operating leverage is higher for companies with lower fixed costs c. Keeping all factors constant, the higher the contribution margin, the higher the operating leverage. d. All of the given answers are true. e. If the degree of operating leverage higher for a company, this means that the company is more risky than another company with low degree of operating leverage.arrow_forwardThe business risk of a company is most accurately measured by the company's: a. Debt-to-equity ratio b. Efficiency in using assets to generate sales c. Operating leverage and level of uncertainly about demand output prices and competitionarrow_forward
- Answer true or false. 1. According to the economic order quantity model, the total period cost would depend, among other things, on the size of each order.2. According to the economic order quantity model, there is no lead time for delivery of goods.3. Working capital is the capital of the company.4. Acquiring a fixed asset exclusively with long-term debt reduces net working capital.5. It is in the firm's interest to have a high cash balance at all times.arrow_forwardWhich of the following statements about operating leverage is false? O a. If the degree of operating leverage higher for a company, this means that the company is more riskyt another company with low degree of operating leverage. O b. Keeping all factors constant, the higher the contribution margin, the lower the operating leverage. O c. Operating leverage measures how operating income will be affected by changes in sales O d. All of the given answers are true. The degree of operating leverage is higher for comnanies with higher fived costs = here to search - hp %23 6. 7 V 3 4 W E R T' Y 岁 S D F G H K. V M. Σ 00 近arrow_forwardCheck My Work еВook Brandtly Industries invests a large sum of money in R&D; as a result, it retains and reinvests all of its earnings. In other words, Brandtly does not pay any dividends, and it has no plans to pay dividends in the near future. A major pension fund is interested in purchasing Brandtly's stock. The pension fund manager has estimated Brandtly's free cash flows for the next 4 years as follows: $3 million, $6 million, $10 million, and $14 million. After the fourth year, free cash flow is projected to grow at a constant 4%. Brandtly's WACC is 11%, the market value of its debt and preferred stock totals $52 million, the firm has $15 million in nonoperating assets, and it has 8 million shares of common stock outstanding. a. What is the present value of the free cash flows projected during the next 4 years? Do not round intermediate calculations. Round your answer to the nearest dollar. Write out your answers completely. For example, 13 million should be entered as…arrow_forward
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