Company P is a regional pizza restaurant chain. The given details are as follows, EBIT is $120 million, Tax rate is 25%, Risk-free rate of return is 6%, Market risk premium is 6%, Outstanding shares 10 million. As of now company is financed with equity only, there is no debt. Now, the company wanted to raise capital by using some debt. When the company were to recapitalize, then debt would be issued, and funds received would be used as repurchase stock. To discuss: Business risk and factors influence firm’s business risk.

Question

Give typing answer with explanation and conclusion 5. Which of the following statements is correct? A-- All the answers are correct. B-- A more direct method of calculating the DOL is to use the following equation is DOL = (Sales - Variable Costs)/EBIT. C-- Because the amount of debt is determined by managerial choice, the business risk that a firm faces is also determined by management. D-- Fixed costs are those costs that are expected to change at the same rate as the firm’s sales. E-- If a firm’s operating costs are all variable, then any variation in sales will be less than the variation in EBIT.

Answer 1

Question

Chapter 15, Problem 2MC

b)

1)

Summary Introduction

Case summary:

Company P is a regional pizza restaurant chain. The given details are as follows,

EBIT is $120 million,

Tax rate is 25%,

Risk-free rate of return is 6%,

Market risk premium is 6%,

Outstanding shares 10 million.

As of now company is financed with equity only, there is no debt. Now, the company wanted to raise capital by using some debt. When the company were to recapitalize, then debt would be issued, and funds received would be used as repurchase stock.

To discuss: Business risk and factors influence firm’s business risk.

2)

Summary Introduction

To discuss: Operating leverage and factors influencing operating leverage and calculate the operating leverage when fixed costs are $200, sale price is $15, and variable cost is $10.

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