Question

1. In terms of break-even analysis, which of the following is true?

a. All else equal, an increase in fixed costs will increase the break-even quantity.

b. All else equal, a decrease in variable costs will increase the break-even quantity.

c. All else equal, an increase in the selling price will increase the break-even quantity.

d. All else equal, a decrease in the selling price will decrease the break-even quantity.

2. Firms Haley and Laura are identical except for their financial leverage ratios and interest rates the pay on debt. Each has $10 million in invested capital, has $4 million in EBIT, and is in the 50% federal-plus-state tax bracket. Haley, however, has a debt-to-capital ratio of 60% and pays 10% interest on its debt, whereas Laura has a 40% debt-to-capital ratio and pays 5% on its debt. Neither firm uses preferred stock in its capital structure. What is the ROE for each firm?

a. The ROE is 40% for each firm.

b. The ROE for Haley is 42.5% and the ROE for Laura is 31.7%

c. The Roe for Haley is 24.5% and the ROE for Laura is 26.7%.

d. The ROE is 20% for each firm.

Please, please answer both questions. This is my last available question for this month. Thank you in advance!!

Answer 1

Q1.
Answer is a. All else equal, an increase in fixed cost will increase the break-even quantity
Explanation:
Break even qty = Fixed cosst / CM perunit
With the increase in fixed cost i.e. numerator with all other things being same, the break even units will rise.
Q2.
Answer is b. ROE of Haley is 42.50% and ROE of Laura is 31.7%
Explanaton:
			Haley	laura
Total Invested capital			10	10
Debt %			60%	40%
Total debts			6	4
Total equity			4	6
Now, ROE:
EBIT			4	4
Less: Interest
Haley (6*10%)			0.6
Laura (4*5%)				0.2
EBT			3.4	3.8
Less: Tax @ 50%			1.7	1.9
EAT			1.7	1.9
Divide: Equity			4	6
ROE			42.50%	31.67%