PRIN.OF CORPORATE FINANCE
13th Edition
ISBN: 9781260013900
Author: BREALEY
Publisher: RENT MCG
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Question
Chapter 9, Problem 16PS
a.
Summary Introduction
To discuss: The condition of the operating leverage and the encabulator machine’s business risk if it is a fixed price contract.
b.
Summary Introduction
To compute: The
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You run a perpetual encabulator machine, which generates revenues averaging $20 million per year. Raw material costs are 50% of
revenues. These costs are variable-they are always proportional to revenues. There are no other operating costs. The cost of capital
is 9%. Your firm's long-term borrowing rate is 6%.
Now you are approached by Studebaker Capital Corp., which proposes a fixed-price contract to supply raw materials at $10 million per
year for 10 years.
a. What happens to the operating leverage and business risk of the encabulator machine if you agree to this fixed-price contract?
Operating leverage and business risk increases
Operating leverage and business risk decreases
b. Calculate the present value of the encabulator machine with and without the fixed-price contract. (Do not round intermediate
calculations. Enter your answers in dollars not in millions. Round your answers to the nearest whole dollar amount.)
With contract
Without contract
$
Present Value
101,686,818
What is the firm's degree of leverage?
If we consider the effect of taxes, then the degree of operating leverage can be written as:
DOL = 1 + [FC × (1 – TC) – TC × D]/OCF
Consider a project to supply Detroit with 20,000 tons of machine screws annually for automobile production. You will need an initial $3.1 million investment in threading equipment to get the project started; the project will last for five years. The accounting department estimates that annual fixed costs will be $925,000 and that variable costs should be $185 per ton; accounting will depreciate the initial fixed asset investment straight-line to zero over the five-year project life. It also estimates a salvage value of $400,000 after dismantling costs. The marketing department estimates that the automakers will let the contract at a selling price of $295 per ton. The engineering department estimates you will need an initial net working capital investment of $380,000. The tax rate is 22 percent.
a.
What is the DOL at the base-case…
Chapter 9 Solutions
PRIN.OF CORPORATE FINANCE
Ch. 9 - (VAR.P and STDEV.P) Choose two well-known stocks...Ch. 9 - (AVERAGE, VAR.P and STDEV.P) Now calculate the...Ch. 9 - (SLOPE) Download the Standard Poors index for the...Ch. 9 - Definitions Define the following terms: a. Cost of...Ch. 9 - True/false True or false? a. The company cost of...Ch. 9 - Company cost of capital Quark Productions (Give...Ch. 9 - Company cost of capital The total market value of...Ch. 9 - Company cost of capital You are given the...Ch. 9 - Company cost of capital Nero Violins has the...Ch. 9 - WACC A company is 40% financed by risk-free debt....
Ch. 9 - WACC Binomial Tree Farms financing includes 5...Ch. 9 - Prob. 10PSCh. 9 - Measuring risk The following table shows estimates...Ch. 9 - Prob. 12PSCh. 9 - Asset betas Which of these projects is likely to...Ch. 9 - Asset betas EZCUBE Corp. is 50% financed with...Ch. 9 - Prob. 15PSCh. 9 - Prob. 16PSCh. 9 - Prob. 17PSCh. 9 - Fudge factors John Barleycorn estimates his firms...Ch. 9 - Prob. 19PSCh. 9 - Prob. 20PSCh. 9 - Certainty equivalents A project has a forecasted...Ch. 9 - Certainty equivalents A project has the following...Ch. 9 - Prob. 23PSCh. 9 - Beta of costs Suppose that you are valuing a...Ch. 9 - Fudge factors An oil company executive is...
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