SUPPOSE QUICKCHARGE CORPORATION MANUFACTURES PHONE CHARGERS. THEY SELL THEIR CHARGERS FOR $20. THEIR FIXED OPERATING COSTS ARE $100,000 AND THEIR VARIABLE OPERATING COSTS ARE $10 PER CHARGER. CURRENTLY THEY ARE SELLING 30,000 CHARGERS PER YEAR

SUPPOSE QUICKCHARGE CORPORATION MANUFACTURES PHONE CHARGERS. THEY SELL THEIR CHARGERS FOR $20. THEIR FIXED OPERATING COSTS ARE $100,000 AND THEIR VARIABLE OPERATING COSTS ARE $10 PER CHARGER. CURRENTLY THEY ARE SELLING 30,000 CHARGERS PER YEAR

Case-LEVERAGE, CAPITAL STRUCTURE, AND DIVIDEND POLICY
Before starting on this assignment, make sure to carefully review the background readings. Part A requires you to make some computations, and Part B requires you to analyze some scenarios using your knowledge of the concepts. So make sure to go through the computational examples in the required readings and also thoroughly review the key concepts before starting on this assignment.

Case Assignment

Part A: Quantitative Problems

1. Suppose QuickCharge Corporation manufactures phone chargers. They sell their chargers for $20. Their fixed operating costs are $100,000 and their variable operating costs are $10 per charger. Currently they are selling 30,000 chargers per year.

A. What is QuickCharge’s EBIT (earnings before interest and taxes) at current sales of 30,000?

B. What is QuickCharge’s breakeven point?

C. Calculate the EBIT if QuickCharge’s sales increase 50% to 45,000 chargers. What is the percent of change in EBIT under this increase in sales? Also, calculate the EBIT if the company’s sales decrease 50% to 15,000 chargers. What is the percent of change in EBIT under this decrease in sales?

D. What is QuickCharge’s degree of operating leverage? Based on your computation, what does its operating leverage say about QuickCharge’s business risk?

2. The StayDry Umbrella Corporation will have an EBIT of $100,000 if there is a normal amount of rain this year. But if there is a drought, they will have an EBIT of only $50,000. The interest rate on debt is 10%, and the tax rate is 35%. The company does not pay any preferred dividends.

A. If StayDry has zero debt and 50,000 outstanding shares, what will its EPS (earnings per share) be if there is normal rain? What will its EPS be if there is a drought? What is its DFL (degree of financial leverage)?

B. Now suppose StayDry has decided to take on $300,000 in debt and has used these funds to buy back half of the outstanding shares so now there are only 25,000 outstanding shares. What is the new EPS and DFL for both normal rain and drought?

C. Based on your answers to a) and b) above, what are the trade-offs management has to make between zero debt or $300,000 in debt? What are the benefits and disadvantages of taking on this debt?

Part B: Conceptual Questions

1. For each of the following scenarios, explain whether the situation describes financial risk or business risk. Explain your answers to each scenario using at least one of the references from the background readings:

A. A pharmaceutical company has developed a new cancer treatment drug that has a much higher success rate than other drugs currently in the market. It has the potential to triple the company’s profits. However, the FDA has expressed concern about some side effects, and it is not clear if the FDA will approve the drug.

Explanation & Answer

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