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16-11 Mercury Air’s debt consists of $50,000 in accounts payable, $100,000 in 10 percent notes payable....

16-11

Mercury Air’s debt consists of $50,000 in accounts payable, $100,000 in 10 percent notes payable. And $240,000 in 8 percent bonds. Mercury has no preferred stock. If its marginal tax rate is 35 percent, what is Mercury’s financial breakeven point?

16-14

Stumpy’s Gator Farm forecasts that its net income will be $46,800 this year. The firm’s marginal tax rate is 35 percent, and it must pay $36,000 interest on outstanding debt. Stumpy’s has no preferred stock. What is the firm’s degree of financial leverage (DFL)?

Expert Solution

16-11

Notes payable = $100000 , Interest expense on notes payable = Notes payable x interest rate = $100000 x 10% = 10000

Bonds = 2400000, Interest expense on bonds = Bonds x interest rate = $240000 x 8% = 19200

No interest is paid on accounts payable as it is not interest bearing debt.

Total interest expense = I = Interest expense on notes payable + Interest expense on bonds = 10000 + 19200 = 29200

As there is no preferred stock, hence preferred dividends = D_p = 0

We know that

Financial breakeven point is level of EBIT for which EPS is equal to zero.

Financial Breakeven point = I + [D_p / (1- tax rate)] = 29200 + [ 0 / (1-35%)] = 29200 + 0 = 29200

Hence Financial Breakeven point = $29200

16-14

Net income = $46800, Tax rate = 35%

Net income = EBT(1-tax rate)

EBT = Net income / (1- tax rate ) = 46800 / (1-35%) = 46800 / 0.65 = 72000

Now we know that

EBIT = EBT + Interest = 72000 + 36000 = 108000

Degree of financial leverage = EBIT / EBT = 108000 / 72000 = 1.5

Hence Degree of financial leverage = 1.5

jeff jeffy answered 4 months ago

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