Use the following information for questions 8-11: A company is trying to decide on their use of operating and financial leverage from among four choices. Their Interest Expense is the Interest Rate times Debt. Their Tax Rate is 40%

Option Fixed Costs Variable Costs Debt Interest Rate

1. 20000 70% of Sales 0 0%

2. 50000 40% of Sales 0 0%

3. 20000 70% of Sales 500,000 10%

4. 50000 40% of Sales 500,000 10%

8. What is their Degree of Operating Leverage under option 1 if sales are $200,000?

a) 1 b) 1.5 c) 2 d) 3

9. What is their Degree of Financial Leverage under option 4 if EBIT is $120,000?

a) 1 b) 1.2 c) 1.7 d) 2.2

10. If Sales rise by 10% from 300,000 to 330,000 under option 3, then EBT will increase by what percent?

a) 13% b) 25% c) 35% d) 45%

11. At what level of Sales will the Degree of Operating Leverage = 2 under Option 2?

a) 100,000 b) 166,667 c) 250,000 d) 333,333

12. Company A and Company B have the same EBIT, tax rate, total assets, and Cost of Debt. However, Company A has a higher debt ratio than Company B. Which of the following statements is correct? (ROA = Net Income / Assets and ROE = Net Income / Equity)

a. Company A has a higher net income than Company B.

b. Company A has a lower ROA than Company B.

c. Company A has a lower ROE than Company B.

d. The two companies have the same ROE.

13. Firms with _____________ should have _________________.

Higher Operating Leverage; More Debt

Less Business Risk; More Financial Leverage

Less Volatile EBITs; Less Debt

Lower Operating Leverage; Lower Financial Leverage Omega Corp. currently has 100,000 shares of stock outstanding but is planning on issuing debt in order to buy back stock. Their EBIT is a constant $1,000,000 regardless of how much debt they issue and they pay all net income out as dividends. Their tax rate is 40%. They have estimated the following costs of debt and costs of equity for various levels of debt.

			EBIT =	1,000,000	Tax Rate =	40%		Share	Shares
Debt	rd	re	Net Inc	StkValue	FirmValue	Debt %	WACC	Price	Outstding
0	6.00%	11.00%	600,000	5,454,545	5,454,545	0.00%	11.00%		100,000
500,000	6.30%	11.40%	581,100	5,097,368		8.93%	10.72%	55.97	91,067
1,000,000	6.80%	12.00%	559,200
1,500,000	8.00%	13.00%		4,061,538	5,561,538	26.97%	10.79%	55.62
2,000,000	9.50%	14.50%
2,500,000	11.50%	16.50%		2,590,909	5,090,909	49.11%
3,000,000	14.00%	19.00%		1,831,579	4,831,579

14. What will their Net Income be if they issue $2,000,000 in debt?

a. $190,000 b. $324,000 c. $486,000 d. $810,000

15. What will their Stock Value be if they issue $1,000,000 in debt?

a. $4,190,000 b. $4,660,000 c. $5,600,000 d. $6,710,400

16. What will their WACC be if they issue $2,500,000 in debt?

a. 10.7% b. 11.8% c. 12.7% d. 14.1%

17. What will their Share Price be if they issue $0 in debt?

a. $48.62 b. $51.23 c. $54.55 d. $60

18. What will their Shares Outstanding be if they issue $1,500,000 in debt?

a. 40,615 b. 55,615 c. 62,374 d. 73,023

19. As the level of debt rises, the _______________ always.

a)Cost of Equity rises

b)WACC rises

c)Basic Earning Power falls

d)ROE rises