1. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt 5 C H A P T E R F I V E Operating and Financial Leverage Irwin/McGraw-Hill ©The McGraw-Hill Companies, Inc. 2000

2. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt T 5-1 Figure 5-1 Break-even chart: Leveraged firm Revenues and costs ($ thousands) 200 160 120 100 80 60 40 20 40 50 60 80 100 120 Total Revenue Total costs Variable costs Fixed costs Profit BE Loss Units produced and sold (thousands) Fixed costs ($60,000) Price ($2) Variable costs per unit ($0.80)

3. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt Table 5-2 Volume-cost-profit analysis: Leveraged firm TotalOperating UnitsVariableFixedTotalTotalIncome SoldCostsCosts Costs Revenue(loss) 0060,000 60,000 0(60,000) 20,00016,00060,000 76,000 40,000(36,000) 40,00032,00060,000 92,000 80,000(12,000) 50,00040,00060,000100,000100,000 0 60,00048,00060,000108,000120,000 12,000 80,00064,00060,000124,000160,000 36,000 100,00080,00060,000140,000200,000 60,000 $ $ $ $ $ T 5-2

4. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt T 5-3 Figure 5-2 Break-even chart: Conservative firm Revenues and costs ($ thousands) 200 160 120 80 40 20 40 60 80 100 120 Total Revenue Total costs Variable costs Fixed costs Profit BE Loss Units produced and sold (thousands) Fixed costs ($12,000) Price ($2) Variable costs per unit ($1.60)

5. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt Table 5-3 Volume-cost-profit analysis: Conservative firm 0012,000 12,000 0(12,000. ) 20,000 32,00012,000 44,000 40,000 (4,000. ) 30,000 48,00012,000 60,000 60,000 0 40,000 64,00012,000 76,000 80,000 4,000 60,000 96,00012,000108,000120,00012,000 80,000128,00012,000140,000160,00020,000 100,000160,00012,000172,000200,00028,000 $ $ $ $$ TotalOperating UnitsVariable FixedTotalTotalIncome SoldCostsCosts Costs Revenue(loss) T 5-4

6. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt 0$(60,000)$(12,000) 20,000(36,000)(4,000) 40,000(12,000)4,000 60,00012,000 12,000 80,00036,000 20,000 100,00060,000 28,000... Leveraged Conservative Firm Firm Units (Table 5-2) (Table 5-3) T 5-5 Table 5-4 Operating income or loss

7. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt 1.EBIT (0) Earnings before interest and taxes (EBIT)00 — Interest (I)$(12,000. )$ (4,000. ) Earnings before taxes (EBT)(12,000. )(4,000. ) — Taxes (T) *(6,000. )(2,000. ) Earnings after taxes (EAT)$ (6,000. )$ (2,000. ) Shares8,00024,000 Earnings per share (EPS) $ (0.75) $ (0.08) 2.EBIT ($12,000) Earnings before interest and taxes (EBIT)$12,000$12,000 — Interest (I)12,0004,000 Earnings before taxes (EBT)08,000 — Taxes (T)04,000 Earnings after taxes (EAT)$ 0$ 4,000 Shares8,00024,000 Earnings per share (EPS) 0 $0.17 Plan APlan B (leveraged)(conservative) * The assumption is that large losses can be written off against other income, perhaps in other years, thus providing the firm with a tax savings benefit. The tax rate is 50 percent for ease of computation. T 5-7 Table 5-5 (continued) Impact of financing plan on earnings per share

8. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt 3.EBIT ($16,000) Earnings before interest and taxes (EBIT)$ 16,000$ 16,000 — Interest (I) 12,0004,000 Earnings before taxes (EBT)4,00012,000 — Taxes (T) 2,0006,000 Earnings after taxes (EAT)$ 2,000$ 6,000 Shares8,00024,000 Earnings per share (EPS)$0.25$0.25 4.EBIT ($36,000) Earnings before interest and taxes (EBIT)$ 36,000$ 36,000 — Interest (I)12,0004,000 Earnings before taxes (EBT)24,00032,000 — Taxes (T)12,00016,000 Earnings after taxes (EAT)$ 12,000$ 16,000 Shares8,00024,000 Earnings per share (EPS)$1.50$0.67 Plan APlan B (leveraged)(conservative) T 5-7 Table 5-5 (continued) Impact of financing plan on earnings per share

9. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt 5.EBIT ($60,000) Earnings before interest and taxes (EBIT)$ 60,000$ 60,000 — Interest (I) 12,0004,000 Earnings before taxes (EBT)48,00056,000 — Taxes (T) 24,00028,000 Earnings after taxes (EAT)$ 24,000$ 28,000 Shares8,00024,000 Earnings per share (EPS)$3.00$ 1.17 Plan APlan B (leveraged)(conservative) T 5-7 Table 5-5 Impact of financing plan on earnings per share

10. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt T 5-8 EPS ($) 4 3 2 1 0 -2 0 12 2550 75 100 Plan A 16 EBIT (thousands).25 Plan B Figure 5-4 Financing plans and earnings per share

11. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt Sales (total revenue) (80,000 units @ $2)$160,000 — Fixed costs60,000 — Variable costs ($0.80 per unit)64,000 Operating income$ 36,000 Earnings before interest and taxes$ 36,000 — Interest12,000 Earnings before taxes24,000 — Taxes12,000 Earnings after taxes$ 12,000 Shares8,000 Earnings per share$1.50 Operating leverage Financial leverage T 5-9 Table 5-6 Income statement

12. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt T 5-10 Figure 5-5 Combining operating and financial leverage $ Earnings generated EPS = $1.50 Operating income = EBIT $36,000 Operating leverage Sales = $160,000 Financial leverage $36,000 Leverage impact

13. th 9 ©The McGraw-Hill Companies, Inc. 2000 Foundations of Financial Management E D I T I O N N I N T H Irwin/McGraw-Hill Block Hirt T 5-11 Table 5-7 Operating and financial leverage Sales — $2 per unit $160,000$200,000 — Fixed costs 60,00060,000 — Variable costs ($0.80 per unit)64,00080,000 Operating income (EBIT) 36,00060,000 — Interest12,00012,000 Earnings before taxes24,00048,000 — Taxes12,00024,000 Earnings after taxes$ 12,000$ 24,000 Shares8,0008,000 Earnings per share$1.50$3.00 (80,000 units)(100,000 units)