Chapter 12 Assignment
1. Kelly Products Corp. sells small kitchen gadgets for $12 each. The gadgets have a variable cost of
$3 per unit, and Kelly Products’ fixed operating costs are $180,000 per year. Kelly Products’
capital structure includes 60% debt and 40% equity. Annual interest expense is $30,000, and
the corporate tax rate is 40%.
a. Calculate the break-even point in units. $22,000
b. If Kelly Products sells 35,000 units, calculate the firm’s EBIT and net income.
c. If sales decrease 10% from 35,000 units to 31,500 units, estimate the firm’s expected EBIT and net income.
d. Does Kelly Products use operating leverage and/or financial leverage? Explain.
They use financial leverage since the EBIT increased by a greater % than their sales did.
2. The Max Corp is planning a $3,000,000 expansion this year. The expansion can be financed by issuing either common stock or bonds. The new common stock can be sold for $50 per share. The bonds can be issued with a 12 % coupon rate. The firm’s existing shares of preferred stock pay dividends of $2.00 per share. The company’s corporate income tax rate is 46%.
The company’s balance sheet prior to expansion is as follows:
Current Assets 2,000,000
Fixed Assets 8,000,000
Total Assets 10,000,000
Current Liabilities 1,500,000
8%, $1,000 par value 1,000,000
10%, $1,000 par value 4,000,000
$100 par value 500,000
$2 par value 700,000
Retained Earnings 2,300,000
Total Liabilities and Equity 10,000,000
a. Calculate the indifference level of EBIT between the two plans,
b. If Ebit is expected to be $3 million, which plan will result in higher EPS? Explain.