Company X has a sales price of $4.00 per unit and a variable cost of $3.40 per u
ID: 2719298 • Letter: C
Question
Company X has a sales price of $4.00 per unit and a variable cost of $3.40 per unit; fixed costs are $13,000, no debt, and sales of 250,000 units per year. Company Y has a sales price of $10.00 per unit and a variable cost of $7.00 per unit with fixed costs of $135,000 and sales of 200,000 units per year. Company Y also has interest payments of $60,000 annually. Both companies are in the 40% tax bracket. What is Company X's interest payment annually? and compare the risks of both companies.
Company X has a sales price of $4.00 per unit and a variable cost of $3.40 per unit; fixed costs are $13,000, no debt, and sales of 250,000 units per year. Company Y has a sales price of $10.00 per unit and a variable cost of $7.00 per unit with fixed costs of $135,000 and sales of 200,000 units per year. Company Y also has interest payments of $60,000 annually. Both companies are in the 40% tax bracket. Make sure you answer all 4 parts: a, b, and c.** Type your answers in the gray boxes below the question.* CompanyX Company Y Sales Price per unit Sales (units per year) Total Sales Variable Cost per unit Total Variable Costs Fixed Costs Tax Rate EBIT Interest Expense EBT Income Taxes (40%) Net Income 4.00 10. 00 250, 000 200, 000 $1, 000, 000 3. 40 $850, 000 13, 000. 00 2, 000, 000 7. 00 1, 400, 000 135, 000. 00 40% 40% $137, 000 $137, 000 $54,800 $82, 200 465, 000 $60, 000 $405, 000 $162, 000 $243, 000Explanation / Answer
Answer
a. Compute DOL,DFL and DCL for Company X
DOL = (Sales Total variable Cost)/(Sales-total variable cost-Fixed Cost)
Sales = $1,000,000
Variable cost = 250,000*3.40 = $850,000
Fixed cost = $13,000
DOL =( $1,000,000-850,00)/($1,000,000-$850,000-$13,000)
DOL = $150,000/137,000 = 1.09
DFL = EBIT/(EBIT-Interest) = 137,000/137,000-0 = 1
DCL = DOL*DFL = 1.09*1 = 1.09
b. Compute DOL,DFL and DCL for Company Y
DOL = (Sales Total variable Cost)/(Sales-total variable cost-Fixed Cost)
Sales = $200,000*10= $2,000,000
Variable cost = 200,000*7 = $1,400,000
Fixed cost = $135,000
DOL =( $2,000,000-1,400,000)/($2,000,000-$1,400,000-$135,000)
DOL = $600,000/465,000 = 1.29
DFL = EBIT/(EBIT-Interest) = 465,000/465,000-60,000 = 1.15
DCL = DOL*DFL = 1.29*1.15 = 1.48
c. Compare the relative risk of both comapnies
Company X is entirely dependent on its stockholder’s equity and hence when its operating income or net income increases EPS will remain low as we have many owners. And secondly we have high taxes to be paid
For Company Y we see it enjoys better leverage than Company X even though it has fixed obligations to pay. But at times of slow down company Y will immense pressure in its operating income and thus making payment of fixed obligations will be tougher to made
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