Answered step by step
Verified Expert Solution
Link Copied!

Question

1 Approved Answer

Oleck Inc. produces stereo components that sell at P = $100 per unit. Olecks fixed costs are $200,000, variable costs are $50 per unit, 5,000

Oleck Inc. produces stereo components that sell at P = $100 per unit. Olecks fixed costs are $200,000, variable costs are $50 per unit, 5,000 components are produced and sold each year, EBIT is currently $50,000, and Olecks assets (all equity-financed) are $500,000. Oleck can change its production process by adding $400,000 to assets and $50,000 to fixed operating costs. This change would (1) reduce variable costs per unit by $10 and (2) increase output by 2,000 units, but (3) the sales price on all units would have to be lowered to $95 to permit sales of the additional output. Oleck has tax loss carry-forwards that cause its tax rate to be zero, it uses no debt, and its average cost of capital is 10%.

Suppose Oleck was unable to raise additional equity financing and had to borrow the $400,000 at an interest rate of 10% to make the investment. Use the DuPont equation to find the expected ROA of the investment. Calculate incremental ROA. Should Oleck make the change if debt financing must be used?

Step by Step Solution

There are 3 Steps involved in it

Step: 1

blur-text-image

Get Instant Access to Expert-Tailored Solutions

See step-by-step solutions with expert insights and AI powered tools for academic success

Step: 2

blur-text-image

Step: 3

blur-text-image

Ace Your Homework with AI

Get the answers you need in no time with our AI-driven, step-by-step assistance

Get Started

Recommended Textbook for

Financial Management

Authors: I.M. Pandey

11th Edition

9325982293, 978-9325982291

More Books

Students also viewed these Finance questions