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Breakeven Analysis and Capital Structure

Problem 1: Mike Smith wanted to open up a baseball hat shop. He needs to know how many hats that must be sold in a year to break even. The stores fixed costs for the year are estimated at $85,000. He is planning on selling the hats for $20.00 a piece. His cost per hat is $10.50.

a. Find the operating breakeven point in number of hats.
b. What is the total operating costs at the breakeven volume found in a.
c. A marketing firm is estimating that he will be able to sell an average of 1000 hats per month. Should Mike start the business?
d. What will be the EBIT per month if Mike sells 1000 hats?

Problem 2: Ace Cooling Systems, Inc., has total assets of $20,000,000, EBIT of $2,000,000, and preferred dividends of $250,000 and is taxed at a rate of 40%. In an effort to determine the optimal capital structure, the firm has assembled data on the cost of debt, the number of shares of common stock for various levels of indebtedness, and the overall required return on investment:

Capital structure Cost of No. of common stock shares Required
debt ratio debt, kd return, ks
0.00% 0.00% 200,000 10.00%
15% 8% 170,000 11.00%
30% 9% 150,000 12.00%
45% 12% 110,000 14.00%
60% 15% 80,000 18.00%

a. Calculate earnings per share for each level of indebtedness.
b. Using Equation 12.12 (from the book) calculate the price per share for each level of indebtedness.
c. Choose the best capital structure. Why?

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Problem 1: Mike Smith wanted to open up a baseball hat shop. He needs to know how many hats that must be sold in a year to break even. The stores fixed costs for the year are estimated at $85,000. He is planning on selling the hats for $20.00 a piece. His cost per hat is $10.50.

a. Find the operating breakeven point in number of hats.

Total Fixed Cost= $85,000

Selling Price= $20.00 per unit
Variable cost= $10.50 per unit
Therefore Contribution= $9.50 per unit =$20.-$10.5

Thus, Break even units= 8,947.37 =$85,000/$9.5

or rounding up the number= 8,948 units

the operating breakeven point in number of hats= 8,948 hats per year

b. What is the total operating costs at the breakeven volume found in a.

Number of units= 8,948

Variable cost @ $10.50 per hat= $93,954 =8,948 x $10.5
Fixed cost= $85,000
Total operating cost= $178,954 =$93,954. + $85,000.

Answer: total operating costs at the breakeven volume= $178,954

c. A marketing firm is estimating that he will be able to sell an average of 1000 hats per month. Should Mike start the business?

Number of hats per month= 1,000
Number of hats per year= 12,000 =1,000 x 12

Since this number is greater than brekeven unit= 8,948
Mike should start the business

d. What will be the EBIT per month if Mike sells 1000 hats?

Number of units= 12,000 per year

Sales @ $20.00 per hat= $240,000 =12,000 x $20.
Variable costs @ $10.50 per hat= $126,000 =12,000 x $10.5
Fixed cost= $85,000
EBIT= $29,000 =$240,000. - $126,000. - $85,000.

EBIT per year= $29,000
Therefore, EBIT per month= $2,417 =$29,000 / 12

Answer: EBIT per month= $2,417 ...

Solution Summary

Answers 2 questions on breakeven analysis and earnings per share for different capital structures.

$2.19