Question

Question 3

Samsung is the manufacturer of flat panel TV sets in South Korea. The company is

evaluating two different operating structures which are described below. Samsung has annual

interest expense   of $250,000   with 1,000,000   common   shares   outstanding.   The   firm’s

marginal tax rate is 40%.

.

	Selling price per unit	Fixed costs	Variable cost per unit
Operating Structure A:	$1,000	$500,000	$750
Operating Structure B:	$1,000	$1,200,000	$700

Answer the following questions:

1. For each operating structure, calculate:

	i	EBIT and EPS at 10,000, 20,000, and 30,000 units.
	ii	the degree of operating leverage (DOL) and degree of combined
		leverage (DCL) using 20,000 units as a base sales level.
	iii	the operating breakeven point in units.
(b)	Which operating structure has greater operating leverage and business
	risk?

3. If Samsung projects sales to be 20,000 units, which operating structure

is recommended?                                                                                                                             

Answer 1

a:
i)	Operating Structure A			Operating Structure B
Units	10000	20000	30000	10000	20000	30000
SP per unit	1000	1000	1000	1000	1000	1000
VC per unit	750	750	750	700	700	700
Cont. per unit	250	250	250	300	300	300
Total Cont.	2500000	5000000	7500000	3000000	6000000	9000000
Fixed Cost	500000	500000	500000	1200000	1200000	1200000
EBIT	2000000	4500000	7000000	1800000	4800000	7800000
Interest	250000	250000	250000	250000	250000	250000
EBT	1750000	4250000	6750000	1550000	4550000	7550000
Taxes 0.4	700000	1700000	2700000	620000	1820000	3020000
EAT	1050000	2550000	4050000	930000	2730000	4530000
O/S Com Stock	1000000	1000000	1000000	1000000	1000000	1000000
EPS ($ per share)	1.05	2.55	4.05	0.93	2.73	4.53
ii)
DOL		1.11			1.25		conti/EBIT
DCL		1.18			1.32		conti/EBT
iii)
Operating BEP (units)=500000/250 = 2000							FC/cont per unit
Operating BEP (units)=				1200000/300 = 4000			FC/cont per unit
b: Greater operating leverage and business : Operating Structure B (being higher DOL)
c: If samsung projects sales to be 20000 units, the operating structure B would be recommended
as it produces higher EPS of $2.73 per share, which is the ultimate aim of an organisation.