SORU 26 Olinde Electronics Inc. produces stereo components that sell for P-$100. Olinde's fixed costs are $200000: 5000 components are produced and sold each year; EBIT is currently $50000; and Olinde's assets (all equity financed) are $500000. Olinde estimates that i can change its production process, adding $400000 to investment and $50000 to fixed operating costs. This change will (1) reduce variable costs-peruntb.$10 and (2) increase output by 2000 units, but (3) the sales price on all units will have to be lowered to $95 to permit sales of the additional output. Olinde has tax loss carry-forwards that couse its tax rate to be zero. Olindeusesnadeb,and its average cost of funds is 10%, 3crmsV-molas. (a) Should Olinde make the change? (b) Would Olinde's degree of operating leverage increase or decrease if it made the change? What about its operating breakeven point? (c) Suppose Olinde was unable to raise additional equity financing and had to borrow the $400000 to make the investment at an interest rate of 8%. Use the Du Pont equation to find the expected ROA of the investment. Should Olinde make the change if debt financing must be used? (d) What would Olinde's degree of financial leverage be if the $400000 was borrowed at the 8% interest rate? what would its financial breakeven point be? DI 17 SORU 26 Olinde Electronics Inc. produces stereo components that sell for P-$100. Olinde's fixed costs are $200000: 5000 components are produced and sold each year; EBIT is currently $50000; and Olinde's assets (all equity financed) are $500000. Olinde estimates that i can change its production process, adding $400000 to investment and $50000 to fixed operating costs. This change will (1) reduce variable costs-peruntb.$10 and (2) increase output by 2000 units, but (3) the sales price on all units will have to be lowered to $95 to permit sales of the additional output. Olinde has tax loss carry-forwards that couse its tax rate to be zero. Olindeusesnadeb,and its average cost of funds is 10%, 3crmsV-molas. (a) Should Olinde make the change? (b) Would Olinde's degree of operating leverage increase or decrease if it made the change? What about its operating breakeven point? (c) Suppose Olinde was unable to raise additional equity financing and had to borrow the $400000 to make the investment at an interest rate of 8%. Use the Du Pont equation to find the expected ROA of the investment. Should Olinde make the change if debt financing must be used? (d) What would Olinde's degree of financial leverage be if the $400000 was borrowed at the 8% interest rate? what would its financial breakeven point be? DI 17
