4. You have been handed the task of valuing two firms your firm would like to acquire. And you are required to assess each firm's sensitivity to business cycle and advise management on the degree of business risk associated with each firm. The income statements of the two firms throughout business cycle follow: Recession Firm A Firm B 8.00 10.00 4.00 4.00 Normal Firm A Firm B 10.00 12.00 4.00 4.00 Expansion Firm A Firm B 12.00 14.00 4.00 4.00 32.00 40.00 40.00 48.00 48.00 56.00 Sales units (millions) Price per unit Sales revenue (GHS' million) Fixed costs (GHS' million) Variable costs (GHS' million) Total operating costs (GHS' million) Operating profits (GHS' million) 8.00 8.00 5.00 8.00 5.00 16.00 5.00 20.00 24.00 28.80 24.00 33.60 21.00 32.00 25.00 36.80 29.00 41.60 11.00 8.00 15.00 11.20 19.00 14.40 Required: (a) Compute the degree of operating leverage for each firm (you may consider either the change from normal to recession or normal to expansion, no need to consider both directions) (b) How would you interpret the results in (a) above to management? (c) Compute the degree of operating leverage for the industry. Would you describe the industry as one that would be highly susceptible to the business cycle? (d) Would you advise management to assign higher risk to Firm A than Firm B? Explain in a few words. (e) Distinguish between a defensive industry and cyclical industry? Which one is riskier? 4. You have been handed the task of valuing two firms your firm would like to acquire. And you are required to assess each firm's sensitivity to business cycle and advise management on the degree of business risk associated with each firm. The income statements of the two firms throughout business cycle follow: Recession Firm A Firm B 8.00 10.00 4.00 4.00 Normal Firm A Firm B 10.00 12.00 4.00 4.00 Expansion Firm A Firm B 12.00 14.00 4.00 4.00 32.00 40.00 40.00 48.00 48.00 56.00 Sales units (millions) Price per unit Sales revenue (GHS' million) Fixed costs (GHS' million) Variable costs (GHS' million) Total operating costs (GHS' million) Operating profits (GHS' million) 8.00 8.00 5.00 8.00 5.00 16.00 5.00 20.00 24.00 28.80 24.00 33.60 21.00 32.00 25.00 36.80 29.00 41.60 11.00 8.00 15.00 11.20 19.00 14.40 Required: (a) Compute the degree of operating leverage for each firm (you may consider either the change from normal to recession or normal to expansion, no need to consider both directions) (b) How would you interpret the results in (a) above to management? (c) Compute the degree of operating leverage for the industry. Would you describe the industry as one that would be highly susceptible to the business cycle? (d) Would you advise management to assign higher risk to Firm A than Firm B? Explain in a few words. (e) Distinguish between a defensive industry and cyclical industry? Which one is riskier
