Part A Quantitative Problems Suppose Quickcharge Corporation

Part A Quantitative Problemssuppose Quickcharge Corporation Manufactu

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

What is QuickCharge’s breakeven point? 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?

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

Paper For Above instruction

QuickCharge Corporation operates in the competitive market of electronic accessories, specifically manufacturing and selling phone chargers. Analyzing its financial structure and operational leverage provides insights into its risk profile and strategic decision-making prospects. This paper conducts a comprehensive financial analysis of QuickCharge and the hypothetical case of StayDry Umbrella Corporation, focusing on profitability, leverage, and managerial trade-offs under varying financial scenarios.

Part 1: QuickCharge's Current Financial Overview and Break-Even Analysis

At the current sales level of 30,000 chargers, QuickCharge’s earnings before interest and taxes (EBIT) can be calculated. The firm’s revenue is derived from sales of $20 per charger, totaling $600,000 (30,000 chargers x $20). The variable costs amount to $10 per unit, totaling $300,000 (30,000 x $10). The fixed operating costs are $100,000. Therefore, EBIT is derived by subtracting total variable costs and fixed costs from sales revenue:

EBIT = Total Revenue - Total Variable Costs - Fixed Operating Costs = $600,000 - $300,000 - $100,000 = $200,000.

Breakeven Point Analysis

The breakeven point (BEP) is where total revenue equals total costs, resulting in zero profit. It can be calculated using the formula:

BEP (units) = Fixed Costs / (Price per unit - Variable Cost per unit) = $100,000 / ($20 - $10) = 10,000 chargers.

This means QuickCharge must sell at least 10,000 chargers annually to cover all fixed and variable costs without incurring losses.

Impact of Sales Increase and Decrease

If sales increase by 50% to 45,000 chargers:

Sales Revenue = 45,000 x $20 = $900,000

Variable Costs = 45,000 x $10 = $450,000

EBIT = $900,000 - $450,000 - $100,000 = $350,000

The percentage change in EBIT from the original $200,000 is:

Percent Change = [(New EBIT - Original EBIT) / Original EBIT] x 100 = [(350,000 - 200,000) / 200,000] x 100 = 75%

Similarly, if sales decrease by 50% to 15,000 chargers:

Sales Revenue = 15,000 x $20 = $300,000

Variable Costs = 15,000 x $10 = $150,000

EBIT = $300,000 - $150,000 - $100,000 = $50,000

The percentage decline in EBIT is:

Percent Change = [(50,000 - 200,000) / 200,000] x 100 = -75%

Degree of Operating Leverage (DOL)

The degree of operating leverage at current sales is calculated as:

DOL = Contribution Margin / EBIT

Contribution Margin = Sales - Variable Costs = $600,000 - $300,000 = $300,000

DOL = $300,000 / $200,000 = 1.5

A DOL of 1.5 indicates that a 1% change in sales will lead to a 1.5% change in EBIT, reflecting moderate business risk. Higher leverage implies greater sensitivity of profits to sales fluctuations, thus increasing business risk.

Analysis of StayDry Umbrella Corporation

StayDry’s EBIT varies significantly with weather conditions. With $100,000 EBIT under normal rains and $50,000 under droughts, its earnings are highly weather-dependent, indicating high business risk. Taxes are 35%, and interest costs are relevant if debt is involved.

If debt-free with 50,000 shares:

EPS under normal rain = EBIT / Shares = $100,000 / 50,000 = $2.00 per share

EPS under drought = $50,000 / 50,000 = $1.00 per share

The Degree of Financial Leverage (DFL) measures the sensitivity of EPS to changes in EBIT:

DFL = EBIT / (EBIT - Interest)

Since there is no debt in this scenario, DFL is 1, indicating no financial leverage.

When $300,000 in debt is introduced:

Interest expense = 10% x $300,000 = $30,000

Adjusted EBIT under normal rain = $100,000 - $30,000 = $70,000

Adjusted EBIT under drought = $50,000 - $30,000 = $20,000

Shares repurchased halve the outstanding shares to 25,000.

EPS under normal rain = $70,000 / 25,000 = $2.80

EPS under drought = $20,000 / 25,000 = $0.80

The new DFL:

DOL under normal rain = EBIT / (EBIT - Interest) = $70,000 / ($70,000 - $30,000) = 1.75

DOL under drought = $20,000 / ($20,000 - $30,000) is undefined (negative denominator), indicating extreme financial risk.

Trade-offs of Debt Financing

The analysis reveals pivotal trade-offs in managing debt levels. Zero debt minimizes financial risk and maintains stable EPS, but it forgoes the tax shield benefits that debt provides. Conversely, leveraging with debt enhances EPS during favorable conditions but introduces significant risk, especially if earnings decline, as seen in the drought scenario with high financial leverage resulting in potential insolvency.

Deciding between these options involves assessing the company's risk tolerance and market perceptions. Debt provides tax benefits (interest deductibility), which can increase firm value (Modigliani and Miller, 1963). However, higher debt levels escalate financial risk, making the firm vulnerable to earnings volatility (Vishwanath, 2007). Optimal capital structure theory suggests balancing these factors to maximize firm value while managing risk (Myers, 2001).

Conclusion

In summary, QuickCharge's financial analysis reveals that operating leverage amplifies the impact of sales fluctuations on profits, with a moderate DOL suggesting manageable business risk. The StayDry case illustrates how leverage significantly influences financial risk and EPS variability. The decision to employ debt must consider not only potential benefits like tax shields but also the increased probability of financial distress under adverse conditions. A balanced capital structure, considering both operational and financial leverage, is critical for sustainable growth and risk management.

References

• Modigliani, F., & Miller, M. H. (1963). The cost of capital, corporation finance, and the theory of investment. The American Economic Review, 48(3), 261–297.
• Myers, S. C. (2001). Capital structure. The Journal of Economic Perspectives, 15(2), 81–102.
• Vishwanath, S. (2007). Chapter 19: Optimal capital structure. In Corporate finance: Theory and practice. SAGE Publications India.
• Investopedia. (n.d.). Degree of operating leverage. Retrieved from https://www.investopedia.com/terms/d/degreeofoperatingleverage.asp
• Obi, P. (2014). Capital structure and financial leverage. Purdue University. Retrieved from https://owl.purdue.edu