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.

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th 9 ©The McGraw-Hill Companies, Inc 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

th 9 ©The McGraw-Hill Companies, Inc 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) 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)

th 9 ©The McGraw-Hill Companies, Inc 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, ,00048,00060,000108,000120,000 12,000 80,00064,00060,000124,000160,000 36, ,00080,00060,000140,000200,000 60,000 $ $ $ $ $ T 5-2

th 9 ©The McGraw-Hill Companies, Inc 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) 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)

th 9 ©The McGraw-Hill Companies, Inc 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 64,00012,000 76,000 80,000 4,000 60,000 96,00012,000108,000120,00012,000 80,000128,00012,000140,000160,00020, ,000160,00012,000172,000200,00028,000 $ $ $ $$ TotalOperating UnitsVariable FixedTotalTotalIncome SoldCostsCosts Costs Revenue(loss) T 5-4

th 9 ©The McGraw-Hill Companies, Inc 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, ,00060,000 28, Leveraged Conservative Firm Firm Units (Table 5-2) (Table 5-3) T 5-5 Table 5-4 Operating income or loss

th 9 ©The McGraw-Hill Companies, Inc 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

th 9 ©The McGraw-Hill Companies, Inc 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)$0.25$ 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

th 9 ©The McGraw-Hill Companies, Inc 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

th 9 ©The McGraw-Hill Companies, Inc 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 ($) Plan A 16 EBIT (thousands).25 Plan B Figure 5-4 Financing plans and earnings per share

th 9 ©The McGraw-Hill Companies, Inc 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 $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

th 9 ©The McGraw-Hill Companies, Inc 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

th 9 ©The McGraw-Hill Companies, Inc 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)