question c and d 2. Jim Wilson is considering the possibility of opening his own

Question

question c and d 2. Jim Wilson is considering the possibility of opening his own machine shop. He expects first-year sales to be $600,000, and he feels that his variable costs will be approximately 50% of sales. His fixed costs in the first year will be $250,000. Jim is considering two ways of financing the firm: (a) 60% equity financing and 40% debt at 14%, or (b) 100% equity financing. He can sell common stock to his relatives for $10 per share. Either way, he will need to raise $800,000 (5 marks total) a. Compute his break-even point in dollars. (1 mark) 25o, 0oo B/E in dollor b. Calculate the Degree of Operating Leverage at the expected first-year sales volume. (1 mark) O0 000 300, 000-250,000 c. Calculate the Degree of Financial Leverage and the Degree of Combined Leverage under each of the possible financing plans. (2 marks) Explain the implications of your answers if the machine shop business is highly cyclical. (1 mark) d.

Explanation / Answer

c Method (a) Method (b) Degree of finacial leverage = EBIT/(EBIT-Interest) 50000/(50000-800000*40%*14%) 50000/50000                                                           9.62 1 Degree of Combined leverage=DFL*DOL 9.62*6 1*6 57.72 6 d Cyclical business are those in which demand are not remain same some time it is too high and some time is is very low but company have to keep doing the business even in low period like mines(mining), field (agricultue) etc in this companies tend to have high operating leverage (high fixed costs) and interest to be paid in each period even it is a low period so at the time of taking decision on proprotion of debt& equity this point need to be considered that during the low season whether we would be able to service the interest or/and debt or not.

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