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Finance Chapter 12




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;Bonds;8%, $1,000 par value 1,000,000;10%, $1,000 par value 4,000,000;Preferred Stock;$100 par value 500,000;Common Stock;$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.


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