Question

1. ElecHuit Inc. is in the process of determining whether to purchase a high-capacity machine to make textbooks for the upcoming school year. The high-capacity machine will generate fixed costs of $11,000 per year versus the $2,500 fixed costs of using a low-capacity machine. The variable costs per unit when using the high-capacity machine will be $32. The firm will charge $62 for each textbook and has determined that the high-capacity machine will maximize pretax operating cash flow if sales are greater than 850 books. What is the variable cost per unit under the low-capacity machine scenario?

2. EBITDA is more sensitive to changes in revenue than EBIT. True or False

3.The cost of equity for a firm must take the cost of preferred stock (if any has been issued) that the firm has outstanding into account. T/F

4. If a firm is about to operate in an environment in which there will be a great deal of variability in the level of revenues, then the firm:

	a. should structure its cost structure to have high fixed costs and higher total variable costs.
	b. should structure its cost structure to have high fixed costs and consequently lower per unit variable costs.
	c. should leave the cost structure unchanged.
	d. should structure its cost structure to have low fixed costs and consequently higher per unit variable costs.

Answer 1

1) At 850 units, Costs of high-capcity machine = costs of low capacity machine

cost of high capacity machine for 850 units = Fixed cost + V.Cost = 11000+(850*32) = 38,200

cost of low capacity machine for 850 units = Fixed cost + V.Cost = 2500+(850*VC per unit)

Therefore, 2500+(850*VC per unit) = 38200

VC per unit for low capacity machine = $42 per unit

2) False. Since EBITDA = EBIT+Depreciation and amortization. Thus, any changes in EBIT would have more effect on EBITDA than any changes in revenue.

3) True. If a company has higher preference shares, its risk for the equity shareholder increases. With increased risk, the equity investors would demand higher returns, thus affecting the cost of equity

4) d. Low fixed and high per unit variable costs. Variability in revenues should be mached with the costs. If fixed costs are high, that would result in smaller changes to be recorded in expenses, even in case of high shift in revenue of any period.