Question

In: Accounting

1-) Papers co. generates €10,000,000 in sales. Its variable costs equal 85.00% of sales and its...

1-) Papers co. generates €10,000,000 in sales. Its variable costs equal 85.00% of sales and its fixed costs are €500,000. Therefore, the company's operating income (EBIT) equals €1,000,000. The company estimates that if its sales were to increase 9.5%, its net income would increase 17.50%.

Income tax rate is 35%.

What is the company's interest expense? Build the Income statement, do not round intermediate calculations and present them all.

1.2-) Assume that a firm currently has EBIT of €2,000,000, a degree of total leverage of 6.000, and a degree of financial leverage of 1.875. If sales decline by 20% next year, then what will be the firm's expected EBIT in one year? Do not round intermediate calculations.

1.3-) Given the following information, answer the following questions.

Total Revenue = €3Q
Total Costs = €1,500 + €2Q

a) What is the break-even level of output? (0,5v)
b) If the firm sells 1,300 units, what are its earnings or losses? (0,5v)
c) If sales rise to 2,000 units, what are the firm's earnings or losses? (0,5v)
d) If the total cost equation were TC = €2,000 + €1.80Q what happens to the break-even level of output units?

Solutions

Expert Solution

(1): For both the scenarios we assume the interest expense to be “x”. Thus Net income in base case = (1,000,000-x)*(1-0.35) = 650,000 – 0.65x

Scenario in which sales = 9.5% higher i.e. 10,950,000. Here EBIT = 1,142,500. Thus net income = (1,142,500-x)*(1-0.35) = 742,625 – 0.65x

Now 1.175*(650,000 – 0.65x) = 742,625 – 0.65x

Or 763,750 – 0.76375x = 742,625 – 0.65x

Or 0.11375x = 21,125

Or x = 185,714.29 (rounded to 2 decimal place)

Income statement of the base case:

Sales                   10,000,000.00
less: fixed costs                         500,000.00
less:Variable costs (85% of sales)                     8,500,000.00
EBIT                     1,000,000.00
Less: Interest expenses                         185,714.29
PBT                         814,285.71
Less: tax @ 35% of PBT                         285,000.00
Net Income                         529,285.71

Income statement in case when the sales increases:

Sales (10 million * 1.095)                   10,950,000.00
less: fixed costs                         500,000.00
less:Variable costs (85% of sales)                     9,307,500.00
EBIT                     1,142,500.00
Less: Interest expenses                         185,714.29
PBT                         956,785.71
Less: tax @ 35% of PBT                         334,875.00
Net Income                         621,910.71

1.2: DOL = DTL/DFL = 6/1.875 = 3.20

Using the data we can now determine the change in EBIT. EBIT = % sales * DOL * EBIT

= -20% * 3.20 * 2,000,000

= -1,280,000

Thus EBIT in 1 year = 2,000,000 – 1,280,000

= 720,000

1.3: (a): At break even 3q = 1500+2q

Or q = 1500. Thus break even = 1500 units

(b): Revenue = 3*1300 = 3900. Costs = 1500+(2*1300) = 4100. Thus loss = 3900-4100 = 200 loss

(c ): Revenue = 2000*3 = 6000. Costs = 1500+(2*2000) = 5500. Thus earnings = 6000-5500 = 500 earnings

(d): Here break even will be: 3q = 2000 + 1.8q

Or q = 2000/1.2 = 1,666.67 units. Thus breakeven will rise by 166.67 units from the earlier 1500 units to 1666.67 units now.


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