The Investment Detective The essence of capital budgeting and resource allocatio
ID: 2775923 • Letter: T
Question
The Investment Detective
The essence of capital budgeting and resource allocation is a search for good investments in which to invest the firms capital. The process can be simple when viewed in purely mechanical terms, but a number of subtle issues can obscure the best investment choices. The capital budgeting analyst is necessarily, therefore, a detective who must winnow good evidence from bad. Much of the challenges is knowing what quantitative analysis to generate in the first place.
Q = 20, 000 units
Price = $120
VC= $80
Fixed cost = $450,000
100,000 outstanding shares
Supposed you are a new capital budgeting analyst for a company considering investments in the eight projects listed in Exhibit
Based on the following information and data above prepare Performa income statement. Also, calculate the DOL, DFL, and DTL and earning per share.
Q=20,000 units
Price=$120
VC=$80
Fixed cost=$450,000
100,000 outstanding shares
Assume that the management has a target DTL of 6. How much debt needs to be retired (replace by common stocks) in order to achieve that goal? What would be the new WACC?
Explanation / Answer
Income Statement Per Unit Amount Quantity 20000 Selling Price $120.00 $24,00,000 Less: Variable Cost $80.00 $16,00,000 Contribution $8,00,000 Less: Fixed Cost $4,50,000 Profit $3,50,000 DOL Contribution/EBIT 2.29 DFL EBIT/EBT 1.00 TFL DOL x DFL 2.29 If management has target of TFL = 6 TFL DOL x DFL 6 Contribution/ EBIT x EBIT/EBT 6 Contribution/ (EBIT-Interest) 6 800000(350000-Interest) 216666 Interest
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