Question

Difference in production process (Finance the project the same either way)

Mfg. Corp of America is using an old production process. Under this old process, they expect to have $175,000 of total variable costs,and $90,000 of total fixed costs for expected sales of 8,000 units. The price of each unit is $50. Mfg. Corp. is considering a choice of 2 new processes to use. It's sales will be 11,000 units with either of the new processes in place. Price per unit will remain $50. It's total variable and fixed costs under the new plans are as follows:

Plan A Plan B

Tot. Variable Costs = $75,000 Tot. Var Costs = $30,000

Total Fixed Costs = $150,000 Total Fixed Costs = $250,000

If the firm goes with the new process, it will need to raise $1,000,000.

$300,000 of which would be raised by issuing new bonds at a cost of 12%.

$700,000 would be raised by selling stock at $40 a share.

IT IS GOING TO ISSUE BOTH $300,000 + $700,000 = $1,000,000

The firm currently has $500,000 in debt outstanding at 6%, and has 50,000 shares of stock currently outstanding. The firm has a tax rate of 50%.

A. Fill in the blanks below.

B. Which alternative gives the company the highest EPS at the projected level of sales of each?

C. Compute the DOL, DFL, DTL for both plans.

D. What is the operating break even point (units) for the old process?

E. Which process should the firm use if it is a risk minimizer and profit maximizer?

Plan A Plan B

Labor Intensive Process Capital Intensive Process

SALES _____________ ______________

-VC _____________ ______________

-FC ______________ ______________

EBIT ______________ ______________

- I ______________ ______________

EBT ______________ ______________

- T ______________ ______________

NIAT ______________ ______________________

Answer 1

(A)
		Plan A		Plan B
Sales	(11000*50)	550000		550000
-VC		75000		30000
Contribution		475000		520000
-FC		150000		250000
EBIT		325000		270000
-I	(300000*12%+500000*6%)	66000		66000
EBT		259000		204000
-Tax	@50%	129500		102000
NIAT		129500		102000
(B)
	No of Shares	=50000+(700000/40)
		67500
		Plan A		Plan B
	Earnings after tax	129500		102000
	No of Shares	67500		67500
	EPS	1.918519		1.511111
(c)		Plan A		Plan B
	DOL	=EBIT/Sales
		0.590909		0.490909
	DFL	=EBT/EBIT
		0.796923		0.755556
	DCL	EBT/Sales
		0.470909		0.370909
(D)	Sale price	50
	Variable cost per unit	21.875
	(175000/8000)
	Contribution Per unit	28.125
	Breakeven	=Fixed cost/Contribution per unit
		90000/28.125
		3200	units
(E)	Plan A should be prefferable because it has high profit .