Brought To You

CHAPTER 17
QUESTIONS
17-1 Accounts payable, accrued wages, and accrued taxes increase spontaneously and proportionately
with sales. Retained earnings increase, but not proportionately.
17-2 a. +
b. ─ The firm needs less manufacturing facilities, raw materials, and work in process.
c. + It reduces spontaneous funds; however, it may eventually increase retained earnings.
d. +
e. +
f. + This should stimulate sales, so it might be offset in part by increased profits.
g. 0
h. +
17-3 Breakeven analysis, whether operating or financial, shows:

(a) profit planning in relationship to its main determinants.
(b) the effects of leverage on profitability.
(c) the effects of changes in volume on profitability.
In addition, operating breakeven analysis helps in deciding the desired proportion of fixed costs
to variable costs, and financial breakeven analysis helps in determining whether to finance the
firm with securities that have fixed obligations (debt and preferred stock) or common stock.
Some of the problems with operating breakeven analysis are that it assumes linear cost and
revenue curves that might be unrealistic, and it cannot handle changes in the level of fixed costs.
Financial breakeven analysis suffers from the same problems—that is, it is assumes interest
payments are fixed rather than variable.
17-4 Operating leverage is the presence of fixed costs in the operation of a firm. Operating profits
fluctuate when sales increase or decrease. Because only the variable costs change with sales
volume changes, the operating profits of a firm with a high percentage of fixed costs are
magnified when sales increase—costs increase only by the low percentage of variable costs, not
by the relative change in sales.
17-5 Financial leverage exists when there exists fixed financing costs. The amount of earnings that
can be distributed to common shareholders varies when operating income (EBIT) changes.
Because only the amount of taxes paid changes with increases or decreases in EBIT, changes in
the earnings that can be distributed to common stockholders will be magnified if the firm has a
high degree of financial leverage—taxes increase by the same proportion and the financing costs
do not change by the relative change in EBIT.
1
Chapter 17
17-6 The selling price per unit, the variable cost per unit, and total fixed costs are necessary to
construct an operating breakeven chart. The procedure also can be accomplished by using total
sales dollars, total fixed costs, and total cost per unit.
17-7 Such financial charges as interest and preferred stock dividends and the tax rate are needed to
construct a financial breakeven chart.
17-8 The operating and financial breakeven points will be affected as follows:
Operating Financial
Breakeven Breakeven
a. An increase in the sales price ─ 0
b. A reduction in variable labor costs ─ 0
c. A decrease in fixed operating costs ─ 0
d. Issuing new bonds 0 +
e. Issuing new preferred stock 0 +
f. Issuing new common stock 0 0
Note that those actions that affect the firm’s production function have an impact on the
operating breakeven point, whereas those actions related to financing affect the financial
breakeven point. However, issuing new common stock does not affect the financial breakeven
point because a fixed financial obligation is not created.
17-9 It is generally not possible to specify an optimum planning period. The optimum length of time
over which a financial plan should operate depends on the nature of the firm’s operation. A
utility company, for example, will find it both possible and necessary to draw up a long -range
financial plan covering many years, whereas a company in a less stable industry, or with easily
replicated assets, will budget over much shorter periods.
17-10 Double taxation refers to the fact that corporate income is subject to an income tax, and then
stockholders are subject to a further personal tax on dividends received.
17-11 If the business were organized as a partnership or a proprietorship, its income could be taken
out by the owners without being subject to double taxation. Also, if you expected to have losses
for a few years while the company was getting started, and if you had outside income, the
business losses if you were not incorporated could be used to offset your other income, and
reduce your total tax bill. These factors would lead you to not incorporate the business. An
alternative would be to organize as an S Corporation, if requirements are met. The appropriate
tax rate depends on the owner’s situation. If the owner has substantial other income, then the
major concern would be the business’s marginal contribution to taxes, so the marginal tax rate
would be more relevant. Conversely, if there were no outside income, the average tax rate
would be more relevant.
17-12 Because interest paid is deductible but dividend payments are not, the after-tax cost of debt is
lower than the after-tax cost of equity. This encourages the use of debt rather than equity. This
point is discussed in detail in Chapters 11 and 12.
________________________________________________________________
2
Chapter 17
PROBLEMS
17-1 a. Sales = 10,000 x $50 $500,000

Variable costs = 10,000 x $30 (300,000)
Gross profit $200,000
Fixed operating costs (120,000)
NOI $ 80,000
$120,000
b. Q OpBEP   6,000units
$50  $30
Grossprofit $200,000
c. DOL    2.5 
NOI $80,000
$150,000
17-2 Q OpBEP   200units
$2,500  $1,750
17-3 DOL = 4.0x, so EBIT will change in the same direction by 4 percent for every 1 percent change
in sales.
$720,000  $800,000
%   0.10  10.0%
$800,000
EBIT$720,000 = EBIT$720,000[1 + (%Δ)(DOL)]

= $50,000[1 + (-0.10)(4)]
= $50,000(0.60)
= $30,000
17-4 a. 125,000 units 175,000 units

Sales ($15/unit) $1,875,000 $2,625,000
Variable costs ($10.unit) (1,250,000) (1,750,000)
Fixed costs ( 700,000) ( 700,000)
Gain (Loss) ($ 75,000) $ 175,000
F $700,000
b. QOpBE = = = 140,000 units
P-V $15 - $10
SOpBE = Q x P = (140,000)($15) = $2,100,000
3
Chapter 17
($ millions) Output (thousands)

5.0
Revenues
4.0
Profit
3.0 Total
Operating
SOpBE Costs
2.0
1.0 Loss Fixed Costs
0.0
QOpBE150
0 50 100 200 250 300
FC = 700,000, QOpBE = 140,000, SOpBE = $2,100,000.
c. Using Equation 17-4, the DOLs are:
125,000($15 - $10)
DOL125,000 units = = - 8.3
125,000($15 - $10) - $700,000
If Niendorf is operating at a level of 125,000 units, a 1 percent increase in quantity sold

will produce an 8.3 percent decrease in profits since the DOL is negative.
150,000($5)
DOL150,000 units = = 15.0
150,000($5) - $700,000
175,000($5)
DOL175,000 units = = 5.0
175,000($5) - $700,000
The same results would be found using Equation 17-4a and the data provided in the partial
income statements given in the solution for part a.
17-5 a. Firm A
(1) Fixed costs = $80,000
Variable  Breakeven sales  Fixed cos ts

(2) cos t Breakeven units
$200,000  $80,000
  $4.80
25,000
4
Chapter 17
Sales Breakeven sales $200,000
(3)    $8.00 per unit
price Breakeven units 25,000
Firm B
(1) Fixed costs = $120,000.
(2) Variable costs = $4.80 per unit
(3) Sales price = $8.00 per unit
b. Firm B has the higher degree of operating leverage due to its larger amount of fixed costs.
c. Operating profit = EBIT = Q(P – V) – F
Firm A’s EBITA = Q($8.00 – $4.80) – $ 80,000 = $3.20Q – $ 80,000
Firm B’s EBITB = Q($8.00 – $4.00) – $120,000 = $4.00Q – $120,000
Set the two equations equal to each other:
$3.20Q – $ 80,000 = $4.00Q – $120,000
–$0.8Q = –$40,000
Q = $40,000/$0.80 = 50,000 units.
Sales level = 50,000 units.
At this sales level, both firms earn $80,000:
ProfitA = 50,000($8.00 – $4.80) – $ 80,000 = $160,000 – $ 80,000 = $ 80,000
ProfitB = 50,000($8.00 – $4.00) – $120,000 = $200,000 – $120,000 = $ 80,000
17-6 a. Total assets = Total liabilities & equity = Accounts payable + Long-term debt
+ Common stock + Retained earnings
$1,200,000 = $375,000 + Long-term debt + $425,000 + $295,000
Long-term debt = $105,000.
Total debt = Accounts payable + Long-term debt = $375,000 + $105,000 = $480,000

Alternatively,
Total debt = (Total liabilities & equity) – Common stock – Retained earnings
= $1,200,000 – $425,000 – $295,000 = $480,000
b. Using the projected balance sheet:
5
Chapter 17
Additions (New
2009 (1 + g) Financing, R/E) Pro Forma
Total assets $1,200,000 (1.25) $1,500,000
Current liabilities $ 375,000 (1.25) $ 468,750

Long-term debt 105,000
105,000
Total debt $ 480,000
$ 573,750
Common stock 425,000 75,000* 500,000
Retained earnings 295,000 112,500** 407,500
Total common equity $ 720,000
$ 907,500
Total liabilities and equity $1,200,000 $1,481,250
AFN = Long-term debt = $ 18,750

*
Given in problem that firm will sell new common stock = $75,000.
**
PM = 6%; Payout = 40%; NI2009 = $2,500,000 x 1.25 x 0.06 = $187,500.
Addition to RE = NI x (1 – Payout) = $187,500 x 0.6 = $112,500.
17-7 Cash 100.00 x 2 = 200.00

Accounts receivable 200.00 x 2 = 400.00
Inventories 200.00 x 2 = 400.00
Net fixed assets 500.00 + 0.0 = 500.00
Total assets 1,000.00
1,500.00
Accounts payable 50.00 x 2 = 100.00

Notes payable 150.00
150.00 + 360.00 = 510.00
Accruals 50.00 x 2 = 100.00
Long-term debt 400.00
400.00
Common stock 100.00
100.00
Retained earnings 250.00 + 40 = 290.00
Total liab. & equity 1,000.00
1,140.00
AFN 360.00
Capacity sales = Sales/0.5 = 1,000/0.5 = 2,000. Because 2009 sales are projected to be $2,000,
no additional fixed assets are needed.
Addition to RE = [PM(S2009)](1 – Payout ratio) = [0.05($2,000)](0.4) = $40
$50,000
17-8 a. QOpBE = = 40,000 units
$5(1 - 0.75)
6
Chapter 17
SOpBE = Q x P = (40,000)($5) = $200,000.
b. At operating BEP, EBIT = 0, so the financing section of Straight Arrow’s income

statement would be:
EBIT $ 0
Interest ($10,000)
Earning before taxes ($10,000)
Taxes (40%) 4,000
Net income ($ 6,000)
Preferred dividends ( 0)
Earnings available to common stockholders ($ 6,000)
EPS = ($6,000)/20,000 = ($0.30)
c. Because Straight Arrow has no preferred stock, its financial BEP is $10,000. The number
of sleeves of golf balls that needs to be sold to cover this $10,000 is:
Interest $10,000
Q to cover $10,000 interest  
P-V $5(1 - 0.75)
 8,000 units
Thus, Straight Arrow needs to sell 8,000 sleeves of balls in addition to the operating
breakeven amount of 40,000 sleeves. If Straight Arrow’s sales equal 48,000 sleeves, its
income statement would be:
Sales = 48,000 x $5 $240,000

Variable costs = 48,000 x $5(0.75) ( 180,000)
Gross profit 60,000
Fixed costs ( 50,000)
EBIT 10,000
Interest ($10,000)
Earning before taxes ( 0)
Taxes (40%) 0
Net income 0
Earnings available to common stockholders $ 0
EPS = $0/20,000 = $0.00
d. If sales equal $300,000, the income statement would be:
Sales $300,000
Variable costs (0.75) (225,000)
Gross profit 75,000
Fixed costs ( 50,000)
EBIT 25,000
Interest ($10,000)
Earning before taxes 15,000
Taxes (40%) ( 6,000)
Net income = EAC $ 9,000
7
Chapter 17
EPS = $9,000/20,000 = $0.45

DOL    3.0 
EBIT $25,000
EBIT $25,000
DFL    1.67 
EBIT - I $25,000 - $10,000

DTL = = DOL DFL = = 5.0 
EBIT - I $25,000 - $10,000
$270,000 - $300,000
% = = - 0.10 = - 10.0%
$300,000
EPS$270,000 = $0.45[1 + (-0.10)(5.0)] = $0.225
17-9 a. Magee Computers

Pro Forma Balance Sheet
December 31, 2009
($ millions)
Pro Forma
After
2009 (1 + g) Additions Pro Forma Financing Financing
Cash $ 3.5 (1.2) $ 4.20 $ 4.20
Receivables 26.0 (1.2)
31.20
Inventories 58.0 (1.2) 69.60 69.60
Total current assets $ 87.5
$105.00 $105.00
Net fixed assets 35.0 (1.2) 42.00 42.00
Total assets $122.5
$147.00 $147.00
Accounts payable $ 9.0 (1.2) $ 10.80 $ 10.80

Notes payable 18.0 18.00 +13.44 31.44
Accruals 8.5 (1.2)
10.20
Total current liabilities $ 35.5 $ 39.00 $ 52.44
Mortgage loan 6.0
6.00 6.00
Common stock 15.0
15.00 15.00
Retained earnings 66.0 7.56* 73.56 73.56
Total liab. and equity $122.5 $133.56 $147.00
AFN = $ 13.44
8
Chapter 17
*PM = $10.5/$350 = 3%.
Payout = $4.2/$10.5 = 40%.
NI = $350 x 1.2 x 0.03 = $12.6.
Addition to RE = NI - DIV = $12.6 ─ 0.4($12.6) = 0.6($12.6) = $7.56.
b. Current ratio = $105/$52.44 = 2.00x
The current ratio is poor compared to 2.5x in 2005 and the industry average of 3x.
Debt/Total assets = $58.44/$147 = 39.8%.
The debt ratio is too high compared to 33.9 percent in 2009 and a 30 percent industry
average.
Re turn on (Pr ofit margin)  Sales Net income

 
Equity Stock  Retained earnings equity
$12.60
  0.142  14.2%
$88.56
The rate of return on equity is good compared to 13 percent in 2009 and a 12 percent
industry average.
c. Magee Computers
December 31, 2009
($ millions)
Pro Forma
After
Total curr. assets $ 87.50 (1.2)
$105.00
Net fixed assets 35.00 (1.2) 42.00 42.00
Total assets $122.50
$147.00 $147.00
Accounts payable $ 9.00 (1.2) $ 10.80 $ 10.80
Notes payable 18.00
18.00 <14.28> 3.72
Accruals 8.50 (1.2) 10.20 10.20
Total current liabilities $ 35.50 $ 39.00 $ 24.72
Mortgage loans 6.00
6.00 6.00
Common stock 15.00
15.00 15.00
Retained earnings 66.00
101.28 101.28
Total liab. and equity $122.50 $161.28 $147.00
9
Chapter 17
AFN = <14.28>
*
PM = 3%; Payout = 40%.
ΣNI = NI2010 + NI2011 + NI2012 + NI2009 + NI2013

= 0.03 x ($364 + $378 + $392 + $406 + $420) = $58.8.
Addition to RE = ΣNI ─ ΣDIV = $58.8 ─ $58.8(0.4) = $35.28.
(2) Current ratio = $105/$24.72 = 4.25x (good).
Debt/Total assets = $30.72/$147 = 20.9% (good).
Return on equity = $12.6/$116.28 = 10.84% (low).**

**
The rate of return declines because of the decrease in the debt/assets ratio. The firm
might, with this slow growth, consider a dividend increase. A dividend increase
would reduce future increases in retained earnings, and in turn, common equity,
which would help boost the ROE.
d. Magee probably could carry out either the slow growth or fast growth plan, but under the
fast growth plan (20 percent per year), the risk ratios would deteriorate, indicating that the
company might have trouble with its bankers and would be increasing the odds of
bankruptcy.
17-10 a. Noso Textiles

Pro Forma Income Statement
December 31, 2009
($ thousands)
Pro Forma
2009 (1 + g) 2010
Sales $36,000 (1.15) $41,400
Operating costs (32,440) (1.15) (37,306)
EBIT $ 3,560 $ 4,094
Interest ( 560) ( 560)
EBT $ 3,000 $ 3,534
Taxes (40%) ( 1,200) ( 1,414)
Net income $ 1,800 $ 2,120
Dividends (45%) $ 810 $ 954

Addition to RE $ 990 $ 1,166
Noso Textiles
December 31, 2009
($ thousands)
Pro Forma
After
Cash $ 1,080 (1.15) $ 1,242 $ 1,242
10
Chapter 17
Accounts receivable 6,480 (1.15) 7,452 7,452
Inventories 9,000 (1.15) 10,350 10,350
Total curr. assets $16,560
$19,044 $19,044
Fixed assets 12,600 (1.15) 14,490 14,490
Total assets $29,160
$33,534 $33,534
Accounts payable $ 4,320 (1.15) $ 4,968 $ 4,968

Accruals 2,880 (1.15) 3,312 3,312
Notes payable 2,100 2,100 +2,128 4,228
Total current liabilities $ 9,300 $10,380 $12,508
3,500 3,500
Total debt $12,800 $13,880 $16,008
Common stock 3,500 3,500 3,500
Retained earnings 12,860 1,166* 14,026 14,026
Total liab. and equity $29,160 $31,406 $33,534
AFN = $ 2,128
*
From income statement.
b. Δ interest expense = $2,128 x 0.10 = $213.
1st Pass Financing 2nd Pass

2010 Feedback 2010
Sales $41,400
Operating costs (37,306) (37,306)
EBIT $ 4,094
Interest (560) +213* (773)
EBT $ 3,534 $ 3,321
Taxes (40%) (1,414) (1,328)
Net income $ 2,120 $ 1,993
Dividends (45%) $ 954

Addition to retained earnings $ 1,166 $ 1,096
*
This is the interest at 10 percent on the $2,128 additional notes payable.
Δ in RE because of feedback = $1,096 - $1,166 = -$70.
11
Chapter 17
1st Pass Financing 2nd Pass
2010 Feedback 2010
Total assets $33,534
Accounts payable $ 4,968

Accruals 3,312
Notes payable 4,228
Total current liabilities $12,508
Total debt $16,008
Common stock 3,500
Retained earnings 14,026 -70* 13,956
Total liabilities and equity $33,534 $33,464
AFN = $ 70
*
See income statement.
Thus, the original AFN amount has been reduced after an additional iteration from
$2,128 to $70. The total AFN for both passes is $2,198.

17-11 a. DOL    2.5 
EBIT $4,320
EBIT $4,320 $4,320

DFL     3.0 
EBIT - I $4,320  $2,880 $1,440
Gross profit $10,800 $10,800

DTL     7.5 
EBIT - I $4,320  $2,880 $1,440
b. DOL = 2.5; so for every 1 percent change in sales, EBIT will change by 2.5 percent. DFL
= 3.0; so for every 1 percent change in EBIT, EPS will change by 3.0 percent. Combining
these two leverages, we have DTL = 7.5; so for every 1 percent change in sales, EPS will
change by 7.5 percent (2.5 x 3.0). For example, if Van Auken’s sales decrease by 2 percent,
EBIT will decrease by 5 percent (operating leverage), and this 5 percent decline in EBIT
will result in a 15 percent decrease in EPS (financial leverage). In combination, then,
leverage will cause a 15 percent decrease in EPS when sales decrease by 2 percent, and
vice versa.
c. Van Auken can reduce its total leverage by reducing the degree of operating leverage, the
degree of financial leverage, or both. All else equal, the company can reduce its degree of
operating leverage by reducing fixed operating costs, decreasing the variable cost ratio, or
by increasing the selling prices of the products. The degree of financial leverage can be
reduced by decreasing fixed financial costs, such as interest and preferred dividends.
17-12 a., b., & c. Woods Company

Pro Forma Income Statement
12
Chapter 17
December 31, 2009
($ thousands)
1st Pass AFN 2nd Pass

2009 (1 + g) 2010 Effects 2010
Sales $8,000 (1.2) $9,600 $9,600
Operating costs (7,450) (1.2) (8,940) (8,940)
EBIT $ 550 $ 660 $ 660
Interest ( 150) ( 150) +30* ( 180)
EBT $ 400 $ 510 $ 480
Taxes (40%) ( 160) ( 204) ( 192)
Net income $ 240 $ 306 $ 288
Dividends : $1.04 x 150 = $ 156 $1.10 x 150 = $ 165 +24** $ 189

Addition to RE: $ 84 $ 141 $ 99
Number of shares outstanding = NI/EPS = $240/$1.60 = 150
*Δ in interest expense = ($51 + $248) x 0.10 = $30.
**Δ in 2009 Dividends = # of new shares issued x DPS = $368/$16.96 x $1.10 = $24
Δ in addition to retained earnings = $99 ─ $141 = -$42.
Woods Company
December 31, 2009
($ thousands)
1st Pass AFN 2nd Pass

2009 (1 + g) 2010 Effects 2010
Cash $ 80 (1.2) $ 96 $ 96
Accounts receivable 240 (1.2) 288 288
Inventory 720 (1.2) 864 864
Total current assets $1,040 $1,248 $1,248
Fixed assets 3,200 (1.2) 3,840 3,840
Total assets $4,240
$5,088
Accounts payable $ 160 (1.2) $ 192 $ 192

Accruals 40 (1.2) 48 48
Notes payable 252
+51** 303
Total current liabilities $ 452 $ 492 $ 543
Long-term debt 1,244 1,244 +248** 1,492
Total debt $1,696
$2,035
Common stock 1,605 1,605 +368** 1,973
Retained earnings 939 141* 1,080 -42*** 1,038
Total liab. and equity $4,240 $4,421 $5,046
AFN = $ 667 $ 42
13
Chapter 17
*
See income statement, 1st pass.
**
CA/CL = 2.3; D/A = 40%.
Maximum total debt = 0.4 x $5,088 = $2,035.
Maximum increase in debt = $2,035 ─ $1,736 = $299.
Maximum current liabilities = $1,248/2.3 = $543.
Increase in notes payable = $543 ─ $492 = $51.
Increase in long-term debt = $299 ─ $51 = $248.
Increase in common stock = $667 ─ $299 = $368.
***
See income statement, 2nd pass.
17-13 a. 8,000 units 18,000 units

Sales ($25/watch) $200,000 $450,000
Variable costs ($15/watch) (120,000) (270,000)
Fixed costs (140,000) (140,000)
Gain (loss) ($ 60,000) $ 40,000
F $140,000
b. QOpBE = = = 14,000 units
P-V $10
SOpBE = Q x P = (14,000)($25) = $350,000.
($ thousands)
800
700 Revenues
600 Profit
500 Total
Operating
400
SOpBE Costs
300
200
Loss Fixed Costs
100
0
0 5 10 QOpBE 15 20 25 30
Output (thousands)
FC = 140,000, SOpBE = 350,000, QOpBE = 14,000.
8,000($25 - $15) $80,000

c. DOL8,000 units = = = - 1.33
8,000($25 - $15) - $140,000 - $60,000
18,000($25 - $15) $180,000

DOL18,000 units = = = 4.5
18,000($25 - $15) - $140,000 $40,000
14
Chapter 17
d. If the selling price rises to $31, while the variable cost per unit remains fixed, P ─ V
increases to $16.
F $140,000
QOpBE = = = 8,750 units
P-V $16
SOpBE = Q x P = (8,750)($31) = $271,250.
The breakeven point drops to 8,750 units. The firm now has less operating leverage than
under Parts a and b; hence, the variability in the firm’s profit stream has been decreased,
but the opportunity for magnified profits has also been decreased.
e. If the selling price rises to $31 and the variable cost per unit rises to $23, P ─ V falls to $8.
F $140,000
QOpBE = = = 17,500 units
P-V $8
SOpBE = Q x P = (17,500)($31) = $542,500.
The breakeven point increases to 17,500 units. The firm now has more operating leverage
than under Parts a and b.
17-14 a. 5,000 units 12,000 units

Income ($45/unit) $225,000 $540,000
Variable costs ($20/unit) (100,000) (240,000)
Fixed costs (175,000) (175,000)
Gain (loss) $( 50,000) $125,000
F $175,000
b. QOpBE = = = 7,000 units
P-V $25
SOpBE = 7,000 x $45 = $315,000.
c. 4,000($45 ─ $20) = $100,000 which falls short of covering all fixed charges. However, the
firm's cash flow covers cash fixed charges of $65,000 by a wide margin.
Creditors are advised to be willing to accept late payments from Dellva. The company
generates sufficient cash to pay its cash fixed charges, and has a good cash “throw-off.” If
forced into liquidation, creditors would be fortunate to receive as much as 20 percent of
their claims.
17-15 a. EBITFinBE = $2,000
EBIT $2,000
Interest (2,000)
Earnings before taxes 0
Taxes (40%) 0
Net income $ 0
15
Chapter 17
EPS = $0/1,000 = $0
EBIT $4,500
b. DFL    1.8 
EBIT  I $4,500  2,000
Every 1 percent change in EBIT will result in a 1.8 percent change in EPS.
$600
c. EBITFinBE = $2,000 + = $2,000 + $1,000 = $3,000
1 - 0.40
EBIT $3,000
Interest (2,000)
Earnings before taxes 1,000
Taxes (40%) ( 400)
Net income $ 600
Earnings available to common stockholders $ 0
EPS = $0/1,000 = $0
EBIT $4,500
DFL    3 .0 
EBIT  EBITFinBE $4,500  3,000
16
Chapter 17
INTEGRATIVE PROBLEM
17-16 SUE WILSON IS THE NEW FINANCIAL MANAGER OF NORTHWEST

CHEMICALS (NWC), AN OREGON PRODUCER OF SPECIALIZED
CHEMICALS SOLD TO FARMERS FOR USE IN FRUIT ORCHARDS. SHE IS
RESPONSIBLE FOR CONSTRUCTING FINANCIAL FORECASTS AND FOR
EVALUATING THE FINANCIAL FEASIBILITY OF NEW PRODUCTS.
PART I. FINANCIAL FORECASTING
SUE MUST PREPARE A FINANCIAL FORECAST FOR 2010 FOR NORTHWEST.

NWC’S 2009 SALES WERE $2 BILLION, AND THE MARKETING DEPARTMENT
IS FORECASTING A 25 PERCENT INCREASE FOR 2010. SUE THINKS THE
COMPANY WAS OPERATING AT FULL CAPACITY IN 2009, BUT SHE IS NOT
SURE ABOUT THIS. THE 2009 FINANCIAL STATEMENTS, PLUS SOME OTHER
DATA, ARE GIVEN IN TABLE IP17-1.
TABLE IP17-1. FINANCIAL STATEMENTS AND OTHER DATA ON NWC

($ MILLIONS)
A. 2009 BALANCE SHEET
CASH & SECURITIES $ 20 ACCOUNTS PAYABLE AND ACCRUALS $ 100

ACCOUNTS RECEIVABLE 240 NOTES PAYABLE 100
INVENTORIES 240 TOTAL CURRENT LIABILITIES $ 200
TOTAL CURRENT ASSETS $ 500 LONG-TERM DEBT 100
COMMON STOCK 500
NET FIXED ASSETS 500 RETAINED EARNINGS 200
TOTAL ASSETS $1,000 TOTAL LIABILITIES AND EQUITY $1,000
B. 2009 INCOME STATEMENT
SALES $2,000.00
LESS: VARIABLE COSTS (1,200.00)
FIXED COSTS ( 700.00)
EARNINGS BEFORE INTEREST AND TAXES $ 100.00
INTEREST ( 16.00)
EARNINGS BEFORE TAXES $ 84.00
TAXES (40%) ( 33.60)
NET INCOME $ 50.40
DIVIDENDS (30%) $ 15.12
ADDITION TO RETAINED EARNINGS $ 35.28
17
Chapter 17
C. 2009 KEY RATIOS

NWC INDUSTRY
PROFIT MARGIN 2.52% 4.00%
RETURN ON EQUITY 7.20% 15.60%
DAYS SALES OUTSTANDING (360 DAYS) 43.20 DAYS 32.00 DAYS
INVENTORY TURNOVER 5.00x 8.00x
FIXED ASSETS TURNOVER 4.00x 5.00x
TOTAL ASSETS TURNOVER 2.00x 2.50x
TOTAL DEBT RATIO 30.00% 36.00%
TIMES INTEREST EARNED 6.25x 9.40x
CURRENT RATIO 2.50x 3.00x
PAYOUT RATIO 30.00% 30.00%
ASSUME THAT YOU WERE RECENTLY HIRED AS SUE’S ASSISTANT, AND

YOUR FIRST MAJOR TASK IS TO HELP HER DEVELOP THE FORECAST.
SHE ASKED YOU TO BEGIN BY ANSWERING THE FOLLOWING SET OF
QUESTIONS:
A. ASSUME THAT NWC WAS OPERATING AT FULL CAPACITY IN 2009 WITH

RESPECT TO ALL ASSETS. ESTIMATE THE 2010 FINANCIAL REQUIREMENT
USING THE PROJECTED FINANCIAL STATEMENT APPROACH, MAKING AN
INITIAL FORECAST PLUS ONE ADDITIONAL “PASS” TO DETERMINE THE
EFFECTS OF “FINANCING FEEDBACKS.” ASSUME THAT (1) EACH TYPE OF
ASSET AS WELL AS PAYABLES, ACCRUALS, AND FIXED AND VARIABLE
COSTS GROW AT THE SAME RATE AS SALES; (2) THE PAYOUT RATIO IS
HELD CONSTANT AT 30 PERCENT; (3) EXTERNAL FUNDS NEEDED ARE
FINANCED 50 PERCENT BY NOTES PAYABLE AND 50 PERCENT BY LONG-
TERM DEBT (NO NEW COMMON STOCK WILL BE ISSUED); AND (4) ALL
DEBT CARRIES AN INTEREST RATE OF 8 PERCENT.
ANSWER:
I. INCOME STATEMENT:
2010 Forecast
2009 Forecast Feed-
Actual Basis 1st Pass Back 2nd Pass
Sales $2,000.00 x 1.25 $2,500.00
$2,500.00
Less: Var. costs (60%) (1,200.00) x 1.25 (1,500.00)
1,500.00
Fixed costs (700.00) x 1.25 (875.00) (875.00)
EBIT $ 100.00
$ 125.00 $ 125.00
18
Chapter 17
Interest (8%) (16.00)
(16.00) +14.34a (30.34)
EBT $ 84.00
$ 109.00 $ 94.66
Taxes (40%) (33.60)
(43.60) (37.86)
Net income $ 50.40 $ 65.40 $ 56.80
Dividends (30%) $ 15.12 $ 19.62 $ 17.04

RE addition $ 35.28 $ 45.78 $ 39.76
a
External funds are financed with 50 percent notes payables and 50percent long-term debt, so the change
in interest expense equals 0.08($89.61) + 0.08($89.61) = $7.17 + $7.17 = $14.34.
II. BALANCE SHEET:

2010 Forecast
2009 Forecast Feed-
Actual Basis 1st Pass Back 2nd Pass
Cash & securities $ 20.00 x 1.25 $ 25.00 $ 25.00
Accounts receivable 240.00 x 1.25 300.00 300.00
Inventories 240.00 x 1.25 300.00 300.00
Tot. current assets $ 500.00
$ 625.00 $ 625.00
Net fixed assets 500.00 x 1.25 625.00 625.00
Total assets $1,000.00 $1,250.00 $1,250.00
A/P and accruals $ 100.00 x 1.25 $ 125.00 $ 125.00

Notes payable 100.00 100.00 +89.61a 189.61
Total current liab. $ 200.00
$ 225.00 $ 314.61
Long-term debt 100.00
100.00 +89.61b 189.61
Common stock 500.00
500.00 500.00
Retained earnings 200.00 +45.78 245.78 -6.02c 239.76
Total liab & equity $1,000.00
$1,070.78 $1,243.98
AFN $ 179.22 $ 6.02

Cumulative AFN $ 185.24
a
Δ in notes payable = $179.22(0.5) = $89.61.
b
Δ in long-term debt = $179.22(0.5) = $89.61.
c
Δ in RE = $39.76 - $45.78 = -$6.02. Process would continue until AFN = $0.
B. CALCULATE NWC’S FORECASTED RATIOS, AND COMPARE THEM WITH

THE COMPANY’S 2009 RATIOS AND WITH THE INDUSTRY AVERAGES. HOW
DOES NWC COMPARE WITH THE AVERAGE FIRM IN ITS INDUSTRY, AND IS
THE COMPANY EXPECTED TO IMPROVE DURING THE COMING YEAR?
19
Chapter 17
ANSWER:
Key ratios NWC

2009 2010 Industry
Actual 2nd pass 2009
Profit margin 2.52% 2.27% 4.00%
ROE 7.20% 7.68% 15.60%
Days sales outstanding (DSO) 43.20 days 43.20 days 32.00 days
Inventory turnover 5.00x 5.00x 8.00x
Fixed assets turnover 4.00x 4.00x 5.00x
Total assets turnover 2.00x 2.00x 2.50x
Debt/assets 30.00% 40.34% 36.00%
Times interest earned 6.25x 4.12x 9.40x
Current ratio 2.50x 1.99x 3.00x
Payout ratio 30.00% 30.00% 30.00%
NWC’s profit margin and ROE are only about half as high as the industry average—NWC is not
very profitable relative to other firms in its industry. Further, its DSO is too high, and its inventory
turnover ratio is too low, which indicates that the company is carrying excess inventory and
receivables. In addition, its debt ratio is forecasted to move above the industry average, and its
coverage ratio is low and forecasted to decline even more. The company is not in good shape, and
things do not appear to be improving.
C. SUPPOSE YOU NOW LEARN THAT NWC’S 2009 RECEIVABLES AND

INVENTORIES WERE IN LINE WITH REQUIRED LEVELS, GIVEN THE
FIRM’S CREDIT AND INVENTORY POLICIES, BUT THAT EXCESS CAPACITY
EXISTED WITH REGARD TO FIXED ASSETS. SPECIFICALLY, FIXED ASSETS
WERE OPERATED AT ONLY 75 PERCENT OF CAPACITY.
(1) WHAT LEVEL OF SALES COULD HAVE EXISTED IN 2009 WITH THE
AVAILABLE FIXED ASSETS? WHAT WOULD THE FIXED
ASSETS/SALES RATIO HAVE BEEN IF NWC HAD BEEN OPERATING AT
FULL CAPACITY?
ANSWER:
Full capacity Actual sales $2,000

   $2,667
sales  Percent of capacity at which  0.75
 fixed assets were operated 
 
Because the firm started with excess fixed asset capacity, it will not have to add as much fixed
assets during 2010 as was originally forecasted:
T arg et Actual sales $500

   18.75%7
FA / Sales ratio Full capacity sales $2,667
The additional fixed assets needed equal 0.1875(Predicted sales ─ Capacity sales) if predicted sales
exceed capacity sales, otherwise no new fixed assets will be needed. In this case, Predicted sales =
1.25($2,000) = $2,500, which is less than capacity sales; so the expected sales growth will not require any
additional fixed assets.
20
Chapter 17
C. (2) HOW WOULD THE EXISTENCE OF EXCESS CAPACITY IN FIXED ASSETS

AFFECT THE ADDITIONAL FUNDS NEEDED DURING 2010?
ANSWER: We had previously found an AFN of $185.24 using two passes through the balance sheet
method. This AFN value was based on an increase in fixed assets equal to 0.25($500) = $125. As noted
earlier, if NWC was operating at 75 percent of capacity in 2009, then the level of fixed assets would not
have to be increased to achieve the sales level forecasted for 2010. Therefore, the funds needed will
decline by approximately $125. (The decline will be slightly larger due to reduced interest expenses and
higher retained earnings—the decline is approximately $129.)
D. WITHOUT ACTUALLY WORKING OUT THE NUMBERS, HOW WOULD YOU

EXPECT THE RATIOS TO CHANGE IN THE SITUATION WHERE EXCESS
CAPACITY IN FIXED ASSETS EXISTS? EXPLAIN YOUR REASONING.
ANSWER: We would expect almost all the ratios to improve. With less financing, interest expense would
be reduced. Depreciation and maintenance, in relation to sales, also would decline. These changes would
improve the profit margin and ROE. Also, the total assets turnover ratio would improve. Similarly, with
less debt financing, the debt ratio and the current ratio would both improve, as would the TIE ratio.
Without question, the company’s financial position would be better. One cannot tell exactly how large the
improvement will be without working out the numbers, but when we worked them out (with a spreadsheet
model that requires just one change, a change in capacity utilization from 100 percent to 75 percent), we
obtained the following figures:
2010, 2nd Pass
Key Ratios 2009 If 2009 Was At
Actual 75% Cap. 100% Cap.
Profit Margin 2.52% 2.51% 2.27%
Roe 7.20% 8.44% 7.68%
Days Sales Outstanding 43.20 days 43.20 days 43.20 days
Inventory Turnover 5.00x 5.00x 5.00x
Fixed Assets Turnover 4.00x 5.00x 4.00x
Total Assets Turnover 2.00x 2.22x 2.00x
Debt/Assets 30.00% 33.71% 40.34%
Times Interest Earned 6.25x 6.15x 4.12x
Current Ratio 2.50x 2.48x 1.99x
Payout Ratio 30.00% 30.00% 30.00%
E. BASED ON COMPARISONS BETWEEN NWC’S DAYS SALES OUTSTANDING

(DSO) AND INVENTORY TURNOVER RATIOS WITH THE INDUSTRY AVERAGE
FIGURES, DOES IT APPEAR THAT NWC IS OPERATING EFFICIENTLY WITH
RESPECT TO ITS INVENTORIES AND ACCOUNTS RECEIVABLE? IF THE
COMPANY WAS ABLE TO BRING THESE RATIOS IN LINE WITH THE
INDUSTRY AVERAGES, WHAT EFFECT WOULD THIS HAVE ON ITS AFN AND
ITS FINANCIAL RATIOS?
21
Chapter 17
ANSWER: The DSO and inventory turnover ratio indicate that NWC has excessive inventories and
receivables. The effect of improvements here would be similar to that associated with excess capacity in
fixed assets. Sales could be expanded without proportionate increases in current assets. (Actually, these
items probably could be reduced even if sales did not increase.) Thus, the AFN would be less than
previously determined, and this would reduce financing and possibly other costs (as we will see in chapter
14, there might be other costs associated with reducing the firm’s investment in accounts receivable and
inventory), which would lead to improvements in most of the ratios. (The current ratio would decline
unless the funds freed up were used to reduce current liabilities, which probably would be done.)
Again, to get a precise forecast, we would need some additional information, and we would need to
modify the financial statements. We will revisit this aspect of the problem in chapter 14.
F. HOW WOULD CHANGES IN THESE ITEMS AFFECT THE AFN? (1) THE
DIVIDEND PAYOUT RATIO, (2) THE PROFIT MARGIN, (3) PLANT CAPACITY,
AND (4) NWC BEGINS BUYING FROM ITS SUPPLIERS ON TERMS WHICH
PERMIT IT TO PAY AFTER 60 DAYS RATHER THAN AFTER 30 DAYS.
(CONSIDER EACH ITEM SEPARATELY AND HOLD ALL OTHER THINGS
CONSTANT.)
ANSWER:
(1) If the payout ratio were reduced, then more earnings would be retained, and this would reduce the
need for external financing, or AFN.
(2) If the profit margin goes up, then both total and retained earnings will increase, and this will
reduce the amount of AFN.
(3) The greater the unused capacity of the plant, the less AFN will be, because the increase in fixed
assets needed to support an increase in sales will be less.
(4) If NWC’s payment terms were increased from 30 to 60 days, accounts payable would double, in
turn increasing current and total liabilities. This would reduce the amount of AFN due to a
decreased need for working capital on hand to pay short-term creditors, such as suppliers.
PART II. BREAKEVEN ANALYSIS AND LEVERAGE
ONE OF NWC’S EMPLOYEES RECENTLY PROPOSED THAT NWC SHOULD

EXPAND ITS OPERATIONS AND SELL ITS CHEMICALS IN RETAIL
ESTABLISHMENTS SUCH AS HOME DEPOT AND LOWE'S. TO DETERMINE
THE FEASIBILITY OF THE IDEA, SUE NEEDS TO PERFORM BREAKEVEN
ANALYSIS. THE FIXED COSTS ASSOCIATED WITH PRODUCING AND
SELLING THE CHEMICALS TO RETAIL STORES WOULD BE $60 MILLION,
THE SELLING PRICE PER UNIT IS EXPECTED TO BE $10, AND THE
VARIABLE COST RATIO WOULD BE THE SAME AS IT IS CURRENTLY.
A. WHAT IS THE OPERATING BREAKEVEN POINT BOTH IN DOLLARS AND IN

NUMBER OF UNITS FOR THE EMPLOYEE'S PROPOSAL?
22
Chapter 17
ANSWER: The computation for operating breakeven is:
F $60 million
Q OpBE    15 million units
PV $10(1 - 0.6)
F $60 million
S OpBE    $150 million  15 million units  $10
1   V / P (1 - 0.6)
For the proposal to breakeven, thus produce an operating income equal to zero, NWC must sell
15,000,000 units, or $150,000,000 of the chemical.
B. DRAW THE OPERATING BREAKEVEN CHART FOR THE PROPOSAL. SHOULD

THE EMPLOYEE'S PROPOSAL BE ADOPTED IF NWC CAN PRODUCE AND SELL
20 MILLION UNITS OF THE CHEMICAL?
ANSWER: The breakeven chart is:
350
Total sales revenues
300
250
$ millions
200
SOpBE = $150
Total operating costs
150
100 QOpBE = 15
50 Fixed costs
0
0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30
Units (millions)
If NWC can produce and sell 20 million units of the chemical, the proposal should be adopted. At 20
million units, NWC will produce an operating profit.
C. IF NWC CAN PRODUCE AND SELL 20 MILLION UNITS OF ITS PRODUCT TO

RETAIL STORES, WHAT WOULD BE ITS DEGREE OF OPERATING
LEVERAGE? WHAT WOULD BE NWC’S PERCENT INCREASE IN
OPERATING PROFITS IF SALES ACTUALLY WERE 10 PERCENT HIGHER
THAN EXPECTED?
ANSWER: At 20 million units of sales, the operating section of NWC’s income statement would be:
Sales (20 million units @ $10) $200,000,000

Variable costs (60%, or $6) (120,000,000)
Gross profit $ 80,000,000
Fixed costs (60,000,000)
Net operating income (NOI = EBIT) $ 20,000,000
23
Chapter 17
Gross profit $80,000,000

DOL    4.0 
EBIT $20,000,000
The DOL for this level of sales indicates that for every 1 percent change in sales, NOI, or EBIT, will
change by 4 percent. Therefore, if sales actually were 10 percent higher than expected, EBIT would be 40
percent higher than expected. To show that this is correct, consider the what the operating section of the
income statement would look like if NWC’s sales actually were $200,000,000(1.10) = $220,000,000:

The EBIT of $28,000,000 is 40 percent greater than the EBIT of $20,000,000.
D. ASSUME NWC HAS EXCESS CAPACITY, SO IT DOES NOT NEED TO RAISE

ANY ADDITIONAL EXTERNAL FUNDS TO IMPLEMENT THE PROPOSAL—
THAT IS, ITS 2010 INTEREST PAYMENTS REMAIN THE SAME AS 2009.
WHAT SHOULD BE ITS DEGREE OF FINANCIAL LEVERAGE AND ITS
DEGREE OF TOTAL LEVERAGE? IF THE ACTUAL SALES TURNED OUT TO
BE 10 PERCENT GREATER THAN EXPECTED, AS A PERCENT, HOW MUCH
GREATER WOULD THE EARNINGS PER SHARE BE?
ANSWER: At 20 million units of sales, the financing section of NWC’s income statement would be:
Net operating income (EBIT) $20,000,000

Interest (16,000,000)
Earnings before taxes (EBt) $ 4,000,000
Taxes (40%) 1,600,000
Net income $ 2,400,000
EBIT $20,000,000 $20,000,000

DFL     5.0 
EBIT  I $20,000,000  $16,000,000 $4,000,000
Gross profit $80,000,000 $80,000,000

DTL     4.0  5.0  20.0 
EBIT  I $20,000,000  $16,000,000 $4,000,000
If sales turn out to be 10 percent greater than expected, EPS will be 10% x 20 = 200% greater than
expected.
24
Chapter 17
E. EXPLAIN HOW BREAKEVEN ANALYSIS AND LEVERAGE ANALYSIS CAN BE
USED FOR PLANNING THE IMPLEMENTATION OF THIS PROPOSAL.
ANSWER: Breakeven analysis can be used to help determine the feasibility of the proposal. As the above
analyses show, NWC would have to sell at least 15 million units of the chemical before the proposal will
begin producing a profit. NWC expects to be able to sell 20 million units, so it appears the proposal will
be profitable. Leverage analysis can help determine what the impact on EPS will be if NWC does not
meet its sales expectations. For example, the degree of total leverage, DTL, for this proposal at 20 million
units is 20x; so, if NWC adopts the proposal and sells just 5 percent less than expected, net income will
be 100 percent (5% x 20) less than expected. To see this, the income statement for sales units equal to 19
million = 20 million x 0.95 is given below:

Interest (16,000,000)
Earnings before taxes (EBT) $ 0,000,000
Taxes (40%) 0
Net income $ 0
The degree of total leverage suggests the proposal is fairly risky if the expected level of sales is 20 million
units. If the expected level of sales were much higher, the proposal would not seem as risky.
25
Chapter 17
17-17 Computer-Related Problem
a. INPUT DATA:
Forecasted sales growth:

2010 15.0%
2011 15.0%
2012 15.0%
3013 15.0%
2014 15.0%
AFN financing percentages:
Notes payable 50.0%
Long-term bonds 50.0%
Common stock 0.0%
Debt costs:
Notes payable 12.0%
Tax rate 40.0%
Dividend payout ratio 40.0%
KEY OUTPUT:
2010 AFN $ 7.0

2011 AFN $ 8.3
2012 AFN $ 9.7
2013 AFN $11.4
2014 AFN $13.4
Cumulative AFN $49.8
Ratios: 2009 2010 2011 2012 2013 2014

______ ______ ______ ______ ______ ______
Cur 2.5 2.1 1.8 1.6 1.5 1.4
PM 5.0% 4.7% 4.3% 4.1% 3.8% 3.6%
TATO 1.1 1.1 1.1 1.1 1.1 1.1
ROA 5.6% 5.2% 4.8% 4.5% 4.2% 3.9%
Debt 34.7% 40.1% 45.0% 49.5% 53.6% 57.2%
ROE 8.6% 8.7% 8.8% 8.9% 9.1% 9.2%
Projected income statements (in millions):

Initial Final Initial Final Initial Final Initial Final Initial Final
2010 2010 2011 2011 2012 2012 2013 2013 2014 2014
______ ______ _______ _______ _______ _______ _______ _______ _______ _______
Sales $92.0 $92.0 $105.8 $105.8 $121.7 $121.7 $139.9 $139.9 $160.9 $160.9
Operating costs (82.0) (82.0) (94.3) (94.3) (108.4) (108.4) (124.7) (124.7) (143.4) (143.4)
EBIT $10.0 $10.0 $ 11.5 $ 11.5 $ 13.2 $ 13.2 $ 15.2 $ 15.2 $ 17.5 $ 17.5
Less interest (2.0) (2.8) (2.8) (3.8) (3.8) (5.0) (5.0) (6.4) (6.4) (8.0)
Earnings
before taxes $ 8.0 $ 7.2 $ 8.7 $ 7.7 $ 9.4 $ 8.2 $ 10.2 $ 8.8 $ 11.1 $ 9.5
Taxes (3.2) (2.9) (3.5) (3.1) (3.8) (3.3) (4.1) (3.5) (4.4) (3.8)
NI avail to common $ 4.8 $ 4.3 $ 5.2 $ 4.6 $ 5.6 $ 4.9 $ 6.1 $ 5.3 $ 6.7 $ 5.7
Dividends to common $ 1.9 $ 1.7 $ 2.1 $ 1.8 $ 2.3 $ 2.0 $ 2.5 $ 2.1 $ 2.7 $ 2.3
Additions to RE $ 2.9 $ 2.6 $ 3.1 $ 2.8 $ 3.4 $ 3.0 $ 3.7 $ 3.2 $ 4.0 $ 3.4
26
Chapter 17
Projected balance sheets:
2010 2010 2011 2011 2012 2012 2013 2013 2014 2014
_____ _____ _____ _____ ______ ______ ______ ______ ______ ______
Cash $ 4.6 $ 4.6 $ 5.3 $ 5.3 $ 6.1 $ 6.1 $ 7.0 $ 7.0 $ 8.0 $ 8.0
Accounts rec 13.8 13.8 15.9 15.9 18.3 18.3 21.0 21.0 24.1 24.1
Inventories 18.4 18.4 21.2 21.2 24.3 24.3 28.0 28.0 32.2 32.2
Tot curr assets $36.8 $36.8 $42.3 $42.3 $ 48.7 $ 48.7 $ 56.0 $ 56.0 $ 64.4 $ 64.4
Net plant and equip 46.0 46.0 52.9 52.9 60.8 60.8 70.0 70.0 80.5 80.5
Total assets $82.8 $82.8 $95.2 $95.2 $109.5 $109.5 $125.9 $125.9 $144.8 $144.8
Accounts payable $ 9.2 $ 9.2 $10.6 $10.6 $ 12.2 $ 12.2 $ 14.0 $ 14.0 $ 16.1 $ 16.1
Notes payable 5.0 8.5 8.5 12.7 12.7 17.5 17.5 23.2 23.2 29.9
Accruals 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Total curr liab $14.2 $17.7 $19.1 $23.2 $ 24.8 $ 29.7 $ 31.5 $ 37.2 $ 39.3 $ 46.0
Long-term bonds 12.0 15.5 15.5 19.7 19.7 24.5 24.5 30.2 30.2 36.9
Total debt $26.2 $33.2 $34.6 $42.9 $ 44.5 $ 54.2 $ 56.0 $ 67.4 $ 69.5 $ 82.9
Common stock 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0
Retained earnings 29.9 29.6 32.7 32.3 35.7 35.3 39.0 38.5 42.5 41.9
Tot common equity $49.9 $49.6 $52.7 $52.3 $ 55.7 $ 55.3 $ 59.0 $ 58.5 $ 62.5 $ 61.9
Tot liabs & equity $76.1 $82.8 $87.3 $95.2 $100.2 $109.5 $115.0 $125.9 $132.0 $144.8
2010 2010 2011 2011 2012 2012 2013 2013 2014 2014
______ _____ _______ _____ _______ _____ _______ _____ _______ _____
Add Funds
Needed (AFN) $6.7 $7.0 $7.9 $8.3 $9.3 $9.7 $10.9 $11.4 $12.8 $13.4
Add notes payable $3.4 $3.5 $4.0 $4.1 $4.7 $4.9 $ 5.5 $5.7 $ 6.4 $ 6.7
Add L-T bonds 3.4 3.5 4.0 4.1 4.7 4.9 5.5 5.7 6.4 6.7
Add common stock ($) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Total new
securities $6.7 $7.0 $7.9 $8.3 $9.3 $9.7 $10.9 $11.4 $12.8 $13.4
Under this scenario, one can see a deterioration of the current assets ratio, profit margin,
ROA, and the debt ratio. Note that ROE increases—this is due to the leveraging effect.
This trend clearly indicates an increase in risk.
b. Sales growth = 20%
INPUT DATA:

2010 20.0%
2011 20.0%
2012 20.0%
2013 20.0%
2014 20.0%

Notes payable 50.0%
Common stock 0.0%
Debt costs:
Notes payable 12.0%
Tax rate 40.0%
27
Chapter 17
Key output:
2010 AFN $10.2

2011 AFN $12.6
2012 AFN $15.4
2013 AFN $18.8
2014 AFN $22.9
Ratios: 2009 2010 2011 2012 2013 2014

_____ _____ _____ _____ _____ _____
Cur 2.5 1.9 1.7 1.5 1.3 1.2
PM 5.0% 4.5% 4.1% 3.7% 3.3% 3.0%
TATO 1.1 1.1 1.1 1.1 1.1 1.1
ROA 5.6% 5.0% 4.5% 4.1% 3.7% 3.4%
Debt 34.7% 42.6% 49.5% 55.4% 60.6% 65.2%
ROE 8.6% 8.7% 8.9% 9.2% 9.4% 9.7%

2010 2010 2011 2011 2012 2012 2013 2013 2014 2014
______ ______ _______ _______ _______ _______ _______ _______ _______ _______
Sales $96.0 $96.0 $115.2 $115.2 $138.2 $138.2 $165.9 $165.9 $199.1 $199.1
Operating costs (85.6) (85.6) (102.7) (102.7) (123.2) (123.2) (147.8) (147.8) (177.4) (177.4)
EBIT $10.4 $10.4 $ 12.5 $ 12.5 $ 15.0 $ 15.0 $ 18.0 $ 18.0 $ 21.6 $ 21.6
Less interest (2.0) (3.2) (3.2) (4.7) (4.7) (6.6) (6.6) (8.8) (8.8) (11.6)
Earnings before taxes $ 8.4 $ 7.2 $ 9.3 $ 7.8 $ 10.3 $ 8.5 $ 11.5 $ 9.2 $ 12.8 $ 10.1
Taxes (3.4) (2.9) (3.7) (3.1) (4.1) (3.4) (4.6) (3.7) (5.1) (4.0)
Additions to RE $ 3.0 $ 2.6 $ 3.3 $ 2.8 $ 3.7 $ 3.0 $ 4.1 $ 3.3 $ 4.6 $ 3.6

2010 2010 2011 2011 2012 2012 2013 2013 2014 2014
_____ _____ _____ _____ ______ ______ ______ ______ ______ ______
Cash $ 4.8 $ 4.8 $ 5.8 $ 5.8 $ 6.9 $ 6.9 $ 8.3 $ 8.3 $ 10.0 $ 10.0
Accounts receivable 14.4 14.4 17.3 17.3 20.7 20.7 24.9 24.9 29.9 29.9
Inventories 19.2 19.2 23.0 23.0 27.6 27.6 33.2 33.2 39.8 39.8
Tot curr assets $38.4 $38.4 $46.1 $46.1 $ 55.3 $ 55.3 $ 66.4 $ 66.4 $ 79.6 $ 79.6
Total assets $86.4 $86.4 $103.7 $103.7 $124.4 $124.4 $149.3 $149.3 $179.2 $179.2
Notes payable 5.0 10.1 10.1 16.4 16.4 24.1 24.1 33.5 33.5 44.9
Accruals 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Total curr liab $14.6 $19.7 $21.6 $27.9 $ 30.2 $ 37.9 $ 40.7 $ 50.1 $ 53.4 $ 64.8
Long-term bonds 12.0 17.1 17.1 23.4 23.4 31.1 31.1 40.5 40.5 51.9
Total debt $26.6 $36.8 $38.7 $51.3 $ 53.6 $ 69.0 $ 71.7 $ 90.5 $ 93.9 $116.8
Common stock 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0
Tot liabs & equity $76.6 $86.4 $91.7 $103.7 $109.7 $124.4 $131.3 $149.3 $157.2 $179.2
2010 2010 2011 2011 2012 2012 2013 2013 2014 2014
______ _____ ______ _____ _____ _____ ______ _____ ______ _____
Add Funds
Needed (AFN) $9.8 $10.2 $12.0 $12.6 $14.7 $15.4 $18.0 $18.8 $21.9 $22.9
Add notes payable $4.9 $5.1 $6.0 $6.3 $7.4 $7.7 $ 9.0 $9.4 $11.0 $11.5
Add L-T bonds 4.9 5.1 6.0 6.3 7.4 7.7 9.0 9.4 11.0 11.5
Add common stock ($) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Total new
securities $9.8 $10.2 $12.0 $12.6 $14.7 $15.4 $18.0 $18.8 $21.9 $22.9
28
Chapter 17
Sales growth = 10%.
INPUT DATA:

2010 10.0%
2011 10.0%
2012 10.0%
2013 10.0%
2014 10.0%
Notes payable 50.0%
Common stock 0.0%
Debt costs:
Notes payable 12.0%
Tax rate 40.0%
Key output:
2010 AFN $ 3.8

2011 AFN $ 4.3
2012 AFN $ 4.9
2013 AFN $ 5.5
2014 AFN $ 6.1
Ratios: 2009 2010 2011 2012 2013 2014

_____ _____ _____ _____ _____ _____
Cur 2.5 2.2 2.1 1.9 1.8 1.7
PM 5.0% 4.8% 4.7% 4.5% 4.4% 4.2%
TATO 1.1 1.1 1.1 1.1 1.1 1.1
ROA 5.6% 5.4% 5.2% 5.0% 4.8% 4.7%
Debt 34.7% 37.4% 40.0% 42.4% 44.8% 47.0%
ROE 8.6% 8.6% 8.7% 8.7% 8.8% 8.8%

2010 2010 2011 2011 2012 2012 2013 2013 2014 2014
______ ______ _______ _______ _______ _______ _______ _______ _______ _______
Sales $88.0 $88.0 $ 96.8 $ 96.8 $106.5 $106.5 $117.1 $117.1 $128.8 $128.8
Operating costs (78.4) (78.4) (86.3) (86.3) (94.9) (94.9) (104.4) (104.4) (114.8) (114.8)
EBIT $ 9.6 $ 9.6 $ 10.5 $ 10.5 $ 11.6 $ 11.6 $ 12.7 $ 12.7 $ 14.0 $ 14.0
Less interest (2.0) (2.5) (2.5) (3.0) (3.0) (3.6) (3.6) (4.2) (4.2) (4.9)
Taxes (3.0) (2.8) (3.2) (3.0) (3.4) (3.2) (3.7) (3.4) (3.9) (3.6)
Additions to RE $ 2.7 $ 2.6 $ 2.9 $ 2.7 $ 3.1 $ 2.9 $ 3.3 $ 3.1 $ 3.5 $ 3.3

2010 2010 2011 2011 2012 2012 2013 2013 2014 2014
_____ _____ _____ _____ ______ ______ ______ ______ ______ ______
Cash $ 4.4 $ 4.4 $ 4.8 $ 4.8 $ 5.3 $ 5.3 $ 5.9 $ 5.9 $ 6.4 $ 6.4
Inventories 17.6 17.6 19.4 19.4 21.3 21.3 23.4 23.4 25.8 25.8
Tot curr assets $35.2 $35.2 $38.7 $38.7 $ 42.6 $ 42.6 $ 46.9 $ 46.9 $ 51.5 $ 51.5
Total assets $79.2 $79.2 $87.1 $87.1 $ 95.8 $ 95.8 $105.4 $105.4 $116.0 $116.0
29
Chapter 17
Accounts payable $ 8.8 $ 8.8 $ 9.7 $ 9.7 $ 10.6 $ 10.6 $ 11.7 $ 11.7 $ 12.9 $ 12.9
Notes payable 5.0 6.9 6.9 9.1 9.1 11.5 11.5 14.2 14.2 17.3
Accruals 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Total curr liab $13.8 $15.7 $16.6 $18.8 $ 19.7 $ 22.2 $ 23.2 $ 25.9 $ 27.1 $ 30.2
Long-term bonds 12.0 13.9 13.9 16.1 16.1 18.5 18.5 21.2 21.2 24.3
Total debt $25.8 $29.6 $30.5 $34.8 $ 35.8 $ 40.7 $ 41.7 $ 47.2 $ 48.4 $ 54.5
Common stock 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0
Tot liabs & equity $75.5 $79.2 $83.0 $87.1 $ 91.1 $ 95.8 $100.2 $105.4 $110.1 $116.0
2010 2010 2011 2011 2012 2012 2013 2013 2014 2014
______ _____ ______ _____ _____ _____ ______ _____ ______ _____
Add Funds
Needed (AFN) $3.7 $3.8 $4.1 $4.3 $4.6 $4.9 $ 5.2 $ 5.5 $ 5.8 $ 6.1
Add notes payable $1.8 $1.9 $2.1 $2.2 $2.3 $2.4 $ 2.6 $2.7 $ 2.9 $ 3.1
Add L-T bonds 1.8 1.9 2.1 2.2 2.3 2.4 2.6 2.7 2.9 3.1
Add common stock ($) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Total new
securities $3.7 $3.8 $4.1 $4.3 $4.6 $4.9 $ 5.2 $ 5.5 $ 5.8 $ 6.1
Again, when sales growth is increased to 20 percent, there is an even greater deterioration in the
ratios indicated in Part a. When sales growth is decreased to 10 percent, the deterioration still
continues but not as much.
c. (1) Dividend payout ratio = 70 percent.
INPUT DATA:

2010 15.0%
2011 15.0%
2012 15.0%
2013 15.0%
2014 15.0%
Notes payable 50.0%
Common stock 0.0%
Debt costs:
Notes payable 12.0%
Tax rate 40.0%
Key output:
2010 AFN $ 8.3

2011 AFN $ 9.7
2012 AFN $11.3
2013 AFN $13.1
2014 AFN $15.2
30
Chapter 17
Ratios: 2009 2010 2011 2012 2013 2014
_____ _____ _____ _____ _____ _____
Cur 2.5 2.0 1.7 1.5 1.4 1.3
PM 5.0% 4.6% 4.2% 3.8% 3.5% 3.2%
TATO 1.1 1.1 1.1 1.1 1.1 1.1
ROA 5.6% 5.1% 4.6% 4.2% 3.9% 3.5%
Debt 34.7% 41.7% 47.9% 53.5% 58.4% 62.7%
ROE 8.6% 8.7% 8.9% 9.1% 9.3% 9.5%

2010 2010 2011 2011 2012 2012 2013 2013 2014 2014
______ ______ _______ _______ _______ _______ _______ _______ _______ _______
Sales $92.0 $92.0 $105.8 $105.8 $121.7 $121.7 $139.9 $139.9 $160.9 $160.9
Operating costs (82.0) (82.0) (94.3) (94.3) (108.4) (108.4) (124.7) (124.7) (143.4) (143.4)
EBIT $10.0 $10.0 $ 11.5 $ 11.5 $ 13.2 $ 13.2 $ 15.2 $ 15.2 $ 17.5 $ 17.5
Less interest (2.0) (3.0) (3.0) (4.2) (4.2) (5.5) (5.5) (7.1) (7.1) (8.9)
Taxes (3.2) (2.8) (3.4) (2.9) (3.6) (3.1) (3.9) (3.2) (4.2) (3.4)
Additions to RE $ 1.4 $ 1.3 $ 1.5 $ 1.3 $ 1.6 $ 1.4 $ 1.7 $ 1.5 $ 1.9 $ 1.5

2010 2010 2011 2011 2012 2012 2013 2013 2014 2014
_____ _____ _____ _____ ______ ______ ______ ______ ______ ______
Cash $ 4.6 $ 4.6 $ 5.3 $ 5.3 $ 6.1 $ 6.1 $ 7.0 $ 7.0 $ 8.0 $ 8.0
Inventories 18.4 18.4 21.2 21.2 24.3 24.3 28.0 28.0 32.2 32.2
Tot curr assets $36.8 $36.8 $42.3 $42.3 $ 48.7 $ 48.7 $ 56.0 $ 56.0 $ 64.4 $ 64.4
Total assets $82.8 $82.8 $95.2 $95.2 $109.5 $109.5 $125.9 $125.9 $144.8 $144.8
Notes payable 5.0 9.2 9.2 14.0 14.0 19.7 19.7 26.3 26.3 33.9
Accruals 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Total curr liab $14.2 $18.4 $19.7 $24.6 $ 26.2 $ 31.9 $ 33.7 $ 40.2 $ 42.3 $ 50.0
Long-term bonds 12.0 16.2 16.2 21.0 21.0 26.7 26.7 33.3 33.3 40.9
Total debt $26.2 $34.5 $35.9 $45.6 $ 47.2 $ 58.5 $ 60.4 $ 73.5 $ 75.6 $ 90.8
Common stock 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0
Tot liabs & equity $74.6 $82.8 $85.7 $95.2 $ 98.4 $109.5 $113.1 $125.9 $129.9 $144.8
2010 2010 2011 2011 2012 2012 2013 2013 2014 2014
Add Funds _____ _____ _____ _____ ______ ______ ______ ______ ______ ______
Needed (AFN) $8.2 $8.3 $9.5 $9.7 $11.1 $11.3 $12.9 $13.1 $14.9 $15.2
Add notes payable $4.1 $4.2 $4.8 $4.9 $ 5.5 $ 5.7 $ 6.4 $ 6.6 $ 7.5 $ 7.6
Add L-T bonds 4.1 4.2 4.8 4.9 5.5 5.7 6.4 6.6 7.5 7.6
Add common stock ($) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Total new
securities $8.2 $8.3 $9.5 $9.7 $11.1 $11.3 $12.9 $13.1 $14.9 $15.2
(2) Dividend payout ratio = 20 percent.
INPUT DATA:

2010 15.0%
2011 15.0%
2012 15.0%
2013 15.0%
2014 15.0%
Notes payable 50.0%
Common stock 0.0%
Debt costs:
31
Chapter 17
Notes payable 12.0%
Tax rate 40.0%
Key output:
2010 AFN $ 6.1

2011 AFN $ 7.2
2012 AFN $ 8.6
2013 AFN $10.1
2014 AFN $11.9
Ratios: 2009 2010 2011 2012 2013 2014

_____ _____ _____ _____ _____ _____
Cur 2.5 2.1 1.9 1.7 1.6 1.5
PM 5.0% 4.7% 4.5% 4.2% 4.0% 3.8%
TATO 1.1 1.1 1.1 1.1 1.1 1.1
ROA 5.6% 5.3% 5.0% 4.7% 4.5% 4.2%
Debt 34.7% 39.0% 43.0% 46.7% 50.0% 53.2%
ROE 8.6% 8.6% 8.7% 8.8% 8.9% 9.1%

2010 2010 2011 2011 2012 2012 2013 2013 2014 2014
______ ______ _______ _______ _______ _______ _______ _______ _______ _______
Sales $92.0 $92.0 $105.8 $105.8 $121.7 $121.7 $139.9 $139.9 $160.9 $160.9
Operating costs (82.0) (82.0) (94.3) (94.3) (108.4) (108.4) (124.7) (124.7) (143.4) (143.4)
EBIT $10.0 $10.0 $ 11.5 $ 11.5 $ 13.2 $ 13.2 $ 15.2 $ 15.2 $ 17.5 $ 17.5
Less interest (2.0) (2.7) (2.7) (3.6) (3.6) (4.6) (4.6) (5.8) (5.8) (7.3)
Taxes (3.2) (2.9) (3.5) (3.2) (3.9) (3.4) (4.2) (3.7) (4.7) (4.1)
Additions to RE $ 3.8 $ 3.5 $ 4.2 $ 3.8 $ 4.6 $ 4.1 $ 5.1 $ 4.5 $ 5.6 $ 4.9

2010 2010 2011 2011 2012 2012 2013 2013 2014 2014
_____ _____ _____ _____ ______ ______ ______ ______ ______ ______
Cash $ 4.6 $ 4.6 $ 5.3 $ 5.3 $ 6.1 $ 6.1 $ 7.0 $ 7.0 $ 8.0 $ 8.0
Inventories 18.4 18.4 21.2 21.2 24.3 24.3 28.0 28.0 32.2 32.2
Tot curr assets $36.8 $36.8 $42.3 $42.3 $ 48.7 $ 48.7 $ 56.0 $ 56.0 $ 64.4 $ 64.4
Total assets $82.8 $82.8 $95.2 $95.2 $109.5 $109.5 $125.9 $125.9 $144.8 $144.8
Notes payable 5.0 8.1 8.1 11.7 11.7 16.0 16.0 21.0 21.0 27.0
Accruals 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Total curr liab $14.2 $17.3 $18.6 $22.3 $ 23.8 $ 28.1 $ 30.0 $ 35.0 $ 37.1 $ 43.0
Long-term bonds 12.0 15.1 15.1 18.7 18.7 23.0 23.0 28.0 28.0 34.0
Total debt $26.2 $32.3 $33.7 $40.9 $ 42.5 $ 51.1 $ 52.9 $ 63.0 $ 65.1 $ 77.0
Common stock 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0 20.0
Tot liabs & equity $77.0 $82.8 $88.4 $95.2 $101.4 $109.5 $116.4 $125.9 $133.6 $144.8
2010 2010 2011 2011 2012 2012 2013 2013 2014 2014
______ _____ ______ _____ _____ _____ ______ _____ ______ _____
Add Funds
Needed (AFN) $5.8 $6.1 $6.8 $7.2 $ 8.1 $ 8.6 $ 9.5 $10.1 $11.2 $11.9
Add notes payable $2.9 $3.1 $3.4 $3.6 $ 4.0 $ 4.3 $ 4.8 $ 5.1 $ 5.6 $ 5.9
Add L-T bonds 2.9 3.1 3.4 3.6 4.0 4.3 4.8 5.1 5.6 5.9
Add common stock ($) 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0
Total new
securities $5.8 $6.1 $6.8 $7.2 $ 8.1 $ 8.6 $ 9.5 $10.1 $11.1 $11.9
32
Chapter 17
When the dividend payout is increased to 70 percent, there is a deterioration in the firm’s
ratios indicated in Part a; however, the ratios do not deteriorate as much as in the 20
percent sales growth scenario. When the dividend payout is decreased to 20 percent, the
deterioration still continues but not as much.
From the ratio analysis above, the firm’s ratios are more sensitive to changes in sales
growth rates than to changes in dividend payout.
33
Chapter 17
ETHICAL DILEMMA
COMPETITION-BASED PLANNING—PROMOTION OR PAYOFF?
Ethical dilemma:
Republic Communications Corporation (RCC) has offered you an attractive position in its
financial planning division. The new position would constitute a promotion with a $30,000
increase in salary compared to the job you now have at National Telecommunications, Inc.
(NTI). The problem is that RCC wants you to bring the rate-setting software you developed at
NTI, along with some rate data, with you to the new job. Even though NTI sells its software to
other companies and information concerning telephone rates is available to the public, you know
that such knowledge will help RCC significantly in its attempt to redesign its rate-setting system.
In fact, according to the situation presented in the text, a new and improved rate-setting program
could be worth as much as $200 million per year for RCC. Therefore, the question is whether the
information RCC wants you to take with you to your new job is proprietary to NTI. Should the
rate-setting program and the rate data be considered NTI's privileged information?
Discussion questions:
● What is the ethical dilemma?
In this case, the ethical dilemma arises from the fact that one company wants important
information from a competitor, and the lure to get the information is the offer of a new
job with substantially higher pay. The information will help the company improve its
competitive position, perhaps at the expense of the company from which the information
is derived.
Discussion can be generated by asking the students who they think owns NTI's rate-
setting program. Does the program belong to the person who developed it, or does it
belong to the company? In addition, ask the students to indicate what information they
believe ethically can be taken from one job to another. Does it matter if the new job is
with a company that is in direct competition with the company you are leaving? Why?
● Should you take the new job? If so, should you take the rate-setting program and the rate
data with you to RCC?
It probably is easier to answer the second question first. The answer to this
question is based on whether the information actually is in the public domain--if it is,
then there should not be a problem. For public utilities that are regulated by states' public
utilities commissions, rate information is available upon request. But, according the
situation described in the text, it appears the rate-setting program is available only if it is
purchased from NTI. Therefore, if RCC wants the program, it probably should purchase
it from NTI. In reality, NTI might refuse to sell the program to RCC, because RCC is a
direct competitor. If this occurs, then taking the rate-setting program to the new job with
34
Chapter 17
RCC essentially would constitute industrial espionage. You could always suggest to RCC
that you bring nothing with you except your expertise, which helped develop the program
in the first place. That expertise can be used at RCC to develop a new, and even better,
rate-setting program.
Answering the first question is tough. If you believe RCC only is interested in the
rate-setting program, then you might be tempted to refuse the offer. But, then you lose the
$30,000 increase in salary. If you believe RCC wants to hire you because you truly are an
"up-and-comer," then you should take the job.
● What should RCC do?
RCC should not pressure you to bring the rate-setting program and the rate data
with you. Instead, RCC should make it clear that you are wanted for the new position
because your past accomplishments indicate you have a bright future in the industry and
you deserve the promotion.
References:
The situation presented here parallels a case involving American Airlines and Northwest
Airlines. According to a Wall Street Journal article, American alleged that Northwest attempted
to steal fare-setting computer programs by hiring top managers and those involved with
computerized planning at significant salary increases, and asking them to bring some of their
work with them to their new jobs. It was after its attempts to purchase the program from
American were refused that Northwest began hiring American managers and experts. One of the
former American employees admitted that, before she left American for a position with
Northwest, she sent some information concerning American's fare-setting and planning system to
a top manager at Northwest, who also formerly worked for American. American sued Northwest
to bar the airline from using its planning system and to recover financial damages. Northwest
found the person who originally wrote the equations used in American's planning system; it was
discovered that his concepts came from public sources.
For more information concerning this situation, see the following article:
"Fare Game: Did Northwest Steal American's Systems? The Court Will Decide," The Wall Street
Journal, July 7, 1994, p. A1.
35

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CHAPTER 17

c. + It reduces spontaneous funds; however, it may eventually increase retained earnings.

f. + This should stimulate sales, so it might be offset in part by increased profits.

17-3 Breakeven analysis, whether operating or financial, shows:

17-1 a. Sales = 10,000 x $50 $500,000

EBIT$720,000 = EBIT$720,000[1 + (%Δ)(DOL)]

17-4 a. 125,000 units 175,000 units

SOpBE = Q x P = (140,000)($15) = $2,100,000

($ millions) Output (thousands)

1.0 Loss Fixed Costs

FC = 700,000, QOpBE = 140,000, SOpBE = $2,100,000.

c. Using Equation 17-4, the DOLs are:

If Niendorf is operating at a level of 125,000 units, a 1 percent increase in quantity sold

(1) Fixed costs = $80,000

Variable  Breakeven sales  Fixed cos ts

(1) Fixed costs = $120,000.

(2) Variable costs = $4.80 per unit

(3) Sales price = $8.00 per unit

c. Operating profit = EBIT = Q(P – V) – F

Firm A’s EBITA = Q($8.00 – $4.80) – $ 80,000 = $3.20Q – $ 80,000

Firm B’s EBITB = Q($8.00 – $4.00) – $120,000 = $4.00Q – $120,000

Set the two equations equal to each other:

$3.20Q – $ 80,000 = $4.00Q – $120,000

Q = $40,000/$0.80 = 50,000 units.

Sales level = 50,000 units.

At this sales level, both firms earn $80,000:

ProfitA = 50,000($8.00 – $4.80) – $ 80,000 = $160,000 – $ 80,000 = $ 80,000

ProfitB = 50,000($8.00 – $4.00) – $120,000 = $200,000 – $120,000 = $ 80,000

$1,200,000 = $375,000 + Long-term debt + $425,000 + $295,000

Long-term debt = $105,000.

Total debt = Accounts payable + Long-term debt = $375,000 + $105,000 = $480,000

= $1,200,000 – $425,000 – $295,000 = $480,000

b. Using the projected balance sheet:

Current liabilities $ 375,000 (1.25) $ 468,750

AFN = Long-term debt = $ 18,750

Addition to RE = NI x (1 – Payout) = $187,500 x 0.6 = $112,500.

17-7 Cash 100.00 x 2 = 200.00

Accounts payable 50.00 x 2 = 100.00

Addition to RE = [PM(S2009)](1 – Payout ratio) = [0.05($2,000)](0.4) = $40

SOpBE = Q x P = (40,000)($5) = $200,000.

b. At operating BEP, EBIT = 0, so the financing section of Straight Arrow’s income

EPS = ($6,000)/20,000 = ($0.30)

Sales = 48,000 x $5 $240,000

EPS = $0/20,000 = $0.00

d. If sales equal $300,000, the income statement would be:

Gross profit $75,000

Gross profit $75,000

EPS$270,000 = $0.45[1 + (-0.10)(5.0)] = $0.225

17-9 a. Magee Computers

Accounts payable $ 9.0 (1.2) $ 10.80 $ 10.80

*PM = $10.5/$350 = 3%.

Payout = $4.2/$10.5 = 40%.

NI = $350 x 1.2 x 0.03 = $12.6.

Addition to RE = NI - DIV = $12.6 ─ 0.4($12.6) = 0.6($12.6) = $7.56.

b. Current ratio = $105/$52.44 = 2.00x

Debt/Total assets = $58.44/$147 = 39.8%.

Re turn on (Pr ofit margin)  Sales Net income

ΣNI = NI2010 + NI2011 + NI2012 + NI2009 + NI2013

Addition to RE = ΣNI ─ ΣDIV = $58.8 ─ $58.8(0.4) = $35.28.

(2) Current ratio = $105/$24.72 = 4.25x (good).

Debt/Total assets = $30.72/$147 = 20.9% (good).

Return on equity = $12.6/$116.28 = 10.84% (low).**