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Problem 1

Tubberg Inc. has a single product, which sells for THB45 and has a variable cost of
THB30 per unit.

Fixed operating costs are THB750,000, including depreciation

expenses of THB50,000.
(a) What is the firms break-even point in units?
(b) What is the firms cash break-even point in units?
(c) What is the firms break-even point in sales baht?
(d) What is the firms DOL if sales are 15,000 units above the break-even point?
(e) What is the firms EBIT for the period if Tubbergs sales are 7,500 units below the break-even point?

Problem 2

Now assume that Tubberg (in Problem 1) has begun an impressive modernization program.
To reduce its variable costs to THB15 per unit, the companys annual fixed operating costs
have been allowed to rise to THB2.1 million. Under these new conditions:
(a) What is the firms break-even point in units?
(b) What is the firms break-even point in sales baht?
(c) What is the firms DOL if sales are 15,000 units above the break-even point?
(d) What is the firms EBIT for the period if Tubbergs sales are 7,500 units below the breakeven point?
(e) What are the financial implications of the new level of operating leverage as compared with
Tubbergs operating leverage before the modernization?

Problem 3

Linping Manufacturing is selling 300,000 units of its only product at THB100 per unit.
Variable costs are THB40 per unit, whereas annual fixed operating costs are THB15 million.
(a) What is the firms operating income (EBIT) at this level of sales?
(b) What is the firms DOL at this level of sales?
(c) If sales increase by 5 percent, what is the resulting operating income? Use DOL to answer
this question.
(d) Confirm your answer in Part (c) by preparing an income statement showing the baht levels of
sales, fixed and variable operating costs, and operating income after the 5 percent growth
in sales.

(e) What would happen to operating income if sales decline by 5 percent? Confirm your answer
with a pro forma (forecasted) income statement.

Scott Besley and Eugene F. Brigham, Essentials of Managerial Finance, (13 ed., I.E), Thomson South-Western, 2005.

Problem 4

Chaisee Meekiaw had sales of only THB150,000 last year. However, management
expects this years sales to reach THB187,500 and further estimates that this will cause
operating income (EBIT) to increase by 67.5 percent. What was Chaisees DOL at a
sales level of THB150,000?

Problem 5

Adventure Books sells paperback books for THB6.25 each. The variable cost per book
is THB4.50. At the current annual sales of 150,000 books, the publisher is just breaking
even. It is estimated that if the authors royalties are reduced, the variable cost per
book will drop by THB0.75. Assume the authors royalties are reduced and sales
remain constant; how much more money can the publisher put into advertising (a fixed
operating cost) and still break even?

Problem 6

Educators Inc. will produce 200,000 units this year of the Magic Speller, a learning
device for children. Variable costs are THB40 per unit, and fixed operating costs are
THB3,400,000. What selling price is required for the firm to obtain operating profits of
THB1,800,000 if all 200,000 units are sold?

Problem 7

Olinde Electronics Inc. produces stereo components that sell for THB100 per unit.
Olindes fixed operating costs are THB200,000; 5,000 components are produced and
sold each year; EBIT is currently THB50,000; and Olindes assets (all equity financed)
are THB500,000. Olinde estimates that it can change its production process, adding
THB400,000 to investment and THB50,000 to fixed operating costs. This change will
(1) reduce variable costs per unit by THB10 and (2) increase output by 2,000 units, but
(3) the sales price on all units will have to be lowered to THB95 to sell the 7,000
components. The firm uses no debt, and its WACC is 10 percent. Ignore taxes.
(a) Should Olinde make the change?
(b) Would Olindes DOL increase or decrease if it made the change? What about its
operating break-even point?
(c) Would the new situation expose the firm to more or less business risk than the old one?
(d) Suppose Olinde was unable to raise additional equity financing and had to borrow
the THB400,000 to make the investment at an interest rate of 8 percent. Use the
(extended) DuPont equation to find the expected ROA of the investment. Should
Olinde make the change if debt financing must be used (Hint: Compare ROA with
WACC.).
(e) What would Olindes DFL be if the THB400,000 was borrowed at the 8 percent
interest rate?

Problem 8

At the current sales of THB 500,000, a firms EBIT is THB150,000 and DOL is 1.25.
(a) What are the firms break-even sales in baht?
(b) At the current sales level, what are operating fixed costs?
(c) At the break-even sales level, what are total variable costs in baht?
(d) If the firms EBIT were twice as high as that in this year, what would be the
corresponding sales in baht?
(e) If the firms EBIT were twice as high as that in this year, what would be the
corresponding percentage change of sales from the current sales level?
(f) If the sales next year are forecasted to be THB 450,000, what will be the
expected EBIT?

Problem 9
Revenue and operating costs (THB)

Total revenue

Total operating costs

FCO

Q0=0

Q1

Q2

Q3

Q4

Q (units)

From the graph above:

(a) Is it true that a firm uses an operating leverage?
(b) Is it true that DOLQ1 is negative?
(c) Is it true that DOL at any Q above Q2 is positive?
(d) Is it true that DOLQ3 is greater than DOLQ4?
(e) In absolute terms, is it true that DOLQ2 is the highest?
(f) Is it true that, at all positive sales levels, for one percentage change in sales,
there is more-than-one percentage change in EBIT (ignoring the sign)?
(g) In terms of Q, P, V, and/or FCO, when sales equal Q0, what is the firms EBIT?

Problem 10

The Raya Corporation, which manufactures ski goggles, has decided to also
manufacture ski poles. The ski poles will sell for THB44 per set. Fixed operating costs
are THB480,000 annually. The company expects to sells 30,000 sets of ski poles
during the first year of operations. What is the maximum variable cost per set if the
company is to just break even in its first year of operations?

Problem 11

Financial data of EJ, Inc. at the sales levels of Q1 and Q2 units are presented next.
Answer each question independently unless otherwise noted.
Q1

Q2

Sales (THB)

375,000

425,000

Total variable costs (THB)

255,000

289,000

30,000

46,000

Earnings before interest and taxes (THB)

(a) Find the operating break-even sales.

(b) If sales are expected to be THB437,500, what is the minimum selling
price per unit that the firm could charge so that it breaks even. Assume
Q1 = 15,000, and Q2 = 17,000 units.
(c) Find the DOL's at the two levels of sales, and explain the results.
(d) Find the sales needed if the firm wants to earn THB50,000 EBIT.

Problem 12

The DCL and DOL of Loveprint and Co. are 3 and 1.5, respectively. The firm plans to
replace the existing machine. The new machine will raise the fixed operating costs, but
reduce the variable cost per unit. The financial manager of the firm believes that the
DOL is equal 1.8 after the replacement. She also expects that the maximum DCL the
firm prefers to maintain is 4.5. Loveprint and Co. plans to use no preferred stock.
(a) Find the DFL before the replacement and the maximum DFL after the
replacement.
(b) If the firm expects that the EBIT after the replacement are THB6,000,000,
find the maximum fixed financial costs that the firm could pay off.
(c) After the replacement, what is the firms EBIT that makes the firm
financially break even?
(d) Assume the fixed financial costs before the replacement were THB2,400,000.
What is the maximum additional amount of debt that the firm could borrow
(or else it goes bankrupt) if the interest rate is 15% per annum.

Problem 13

One day, while walking around Taphrachan, Thongkliaw saw the fortuneteller's
crowded. Thus she is interested in doing a fortune-telling business. She started her
business by hiring the 4 most famous fortunetellers in the Thaphrachan area. Each
teller asks for a THB2,500 salary, and food allowances for THB100 a day. Thongkliaw
must pay THB500 monthly for stationary. The price is set at THB50 per time per head,
and 20% of this price will be forwarded to the tellers as the participating allowances.
Assume that there are 30 days a month, and that each question is independent, unless
specified otherwise.
(a) Find the contribution margin per time per head.
(b) In each month, find the minimum number of customers coming to see the
tellers so that Thongkliaw starts earning some profits.
(c) If Thongkliaw wants to make profits of THB6,300 in the first month,
calculate the expected average customers per teller per day.
(d) News about the accuracy of the Thongkliaw's tellers is spread out. Thus,
there are 750 customers in December. Find the DOL in December. Also
explain what the finding means.
(e) If the number of customers is expected to be 795 in January, forecast the
expected earnings in January. Use DOL found in Part (d) to help solve
this problem.
(f) To reward the tellers, Thongkliaw thinks about raising the participating
fees. If, in January, she expects to earn THB8,028 of profits and to have
795 customers, find the maximum participating fees (in baht) per time per
head. (The customers are still charged the same price.)
(g) The expected number of customers in January is 795 because of fame,
but would be as high as 950 if the print ads are around Taphrachan and
vicinity. This could happen because the ads offer discounts to group
customers: customers in groups of 5 will be charged at 70% of the
normal price. Thongkliaw expects that 40% of 950 customers will come
in the groups of 5. Assume that the costs of the print ads are THB1,500
(ignoring the time value of money), that there are still 4 tellers, and that
the forecast is relatively precise. Should Thongkliaw go ahead with the
print ads? Show the calculation. Assume that the participating fees in
baht are still the same as those before discounting.

Problem 14
(a) Given the graphs below, calculate the (total) operating fixed costs, variable costs
per unit, and sales price for Firm A. Firms B (total) fixed operating costs are
THB120,000, its variable costs per unit are THB4, and its sales price is THB8 per
unit.

Revenue and costs (THB thousands)

Firm A
Total revenue

Total operating costs

Total fixed operating costs

Units (thousands)

Revenue and costs (THB thousands)

Firm B
Total revenue

Total operating costs

Total fixed operating costs

Units (thousands)

(b) Which firm has the higher degree of operating leverage? Explain.
(c) At what sales level, in units, do both firms earn that same operating profit?

Problem 15

What would be the effect of each of the following on the firms operating and financial
break-even point? Indicate the effect in the space provided by placing a (+) for an
increase, a (-) for a decrease, and a (0) for no effect. When answering this question,
assume everything except the change indicated is held constant.

Operating Breakeven

Financial Breakeven

(a)

An increase in the sales price

_____________

_____________

(b)

A reduction in the variable cost ratio

_____________

_____________

(c )

A decrease in fixed operating costs

_____________

_____________

(d)

Issuing new bonds

_____________

_____________

(e)

Issuing new preferred stock

_____________

_____________

(f)

Issuing new common stock

_____________

_____________

Problem 16

Van Auken Lumbers 20X0 income statement is shown here:

Van Auken Lumber
Income statement for year ended December 31, 20X0 (THB Thousands)

Revenue from sales

(36,000)

Cost of goods sold

(25,200)

Gross profit

10,800)

Fixed operating costs

(6,480)

Profit before finance costs and income taxes (EBIT)

Finance costs
Profit before income taxes
Income taxes (40%)

4,320)
(2,880)
1,440)
(576)

Profit for year (Net income)

864)

Dividends (50%)

432)

(a) Compute the DOL, DFL, and DTC for Van Auken Lumber.
(b) Interpret the meaning of each of the numerical values computed in Part (a).
(c) Briefly discuss some ways Van Auken Lumber can reduce its DTL.

Problem 17

Gordons Plants has the following partial income statement (THB) for 20X0:
Profit before finance costs and income taxes (EBIT)
Finance costs
Profit before income taxes
Income taxes (40%)

4,500)
(2,000)
2,500)
(1,000)

Profit for year (Net income)

1,500)

Number of common shares

1,000)

(a) If Gordons has no preferred stock, what is its financial breakeven point? Show
that the amount you come up with actually is the financial breakeven by
recreating the portion of income statement shown here for the amount.
(b) What is the DFL for Gordons? What does this value mean?
(c) If Gordons actually has preferred stock that requires payment of dividends equal
to THB600, what would be the financial breakeven point? Show that the amount
you compute is the financial breakeven by recreating the portion of income
statement shown here for the amount. What is the DFL in this case?

Problem 18

Straight Arrow Company manufactures golf balls. It uses no preferred stock. The
following income statement information is relevant for Straight Arrow in 20X1:
Selling price per sleeve of balls
Variable cost of goods sold (% of selling price)

THB5
75%

Fixed operating costs

THB50,000

Interest expense

THB10,000

Corporate tax rate

Number of common shares

40%
20,000

(a) What level of sales does Straight Arrow needs to achieve in 20X1 to breakeven
with respected to operating income?
(b) At its operating breakeven, what will be the EPS for Straight Arrow?
(c) How many sleeves of golf balls (in units) does Straight Arrow need to sell in 20X1
to attain the financial breakeven point?
(d) If Straight Arrow expects its sales to be THB300,000 in 20X1, what are its DOL,
DFL, and DTL?
(e) Based on the DTL in Part (d), compute the EPS Straight Arrow would expect
20X1 if sales actually turn out to be THB270,000.

Problem 19

Newin and Friends Co. has just recovered from a severe slump in business and has
projected sales of THB3,600,000 for the next year. Based on the existing production
equipment, total fixed operating costs and total variable operating costs are expected
to be THB1,200,000 and THB1,800,000, respectively, so that the EBIT will be
THB600,000. The selling price per item produced is THB50.
The firm has a THB1,500,000 five-year promissory note outstanding on which it pays
interest of 15 percent. Newin and Friends Co. plans to pay off the five-year note with
funds borrowed at a lower interest rate.
The production manager has suggests the modernization of the old equipment. This
would result in a 30 percent increase in fixed operating costs and a 20 percent decrease
in per unit variable operating costs.
The general manager agrees with modernization plan as long as the firms risk, as
measured by the DTL, does not change. This could be made possible by the refunding
of the outstanding five-year note. Newin and Friends Co. will borrow THB1,500,000
from a bank in order to pay of the note. Assume that sales price and sales will be
unaffected by the cost change.

How much lower must the interest rate on the new THB1,500,000 loan be for the
modernization plan to become acceptable in the eyes of the manager?

Problem 20

Bunjongsake Corporation will begin operation next year to produce a single product at
a price of THB12 per unit. Bunjongsake Corporation has a choice of two methods of
production: Method A, with variable costs of THB6.75 per unit and fixed operating costs
of THB675,000; and Method B, with variable costs of THB8.25 per unit and fixed
operating costs of THB401,250. To support operations under either production method,
the firm requires THB2,250,000 in assets, and it has established a debt ratio of 40
percent. The cost of debt is 10 percent. The tax rate is 30 percent, but irrelevant to
the problem.
(a) The sales forecast for the coming year is 2,000,000 units. Under which method
would EBIT be more adversely affected if sales did not reach the expected levels?
(b) Given the firms present debt, which method would produce the greater percentage
increase in earnings per share for a given increase in EBIT?
(c) Calculate DTLs under each method, and then evaluate the firms total risk under
each method.
(d) Is there some debt under Method A that would produce the same DTLA as DTLB
that you calculated in Part (c)?

Problem 21

. (C) 30

DCL 3.60
C 1,100,000 700,000
DOL DCL 1.74 3.00
C


DOL 1.80 6

C 8

Problem 22

(S) S
120,000 30
100
S 80 65
20,000 S 0

15
S 210,000
23,000 S (
)

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