Jim Wilson Is Considering the Possibility of Opening His Own

question 28

Essay

Jim Wilson is considering the possibility of opening his own machine shop.He expects first-year sales to be $600,000,and he feels that his variable costs will be approximately 50% of sales.His fixed costs in the first year will be $250,000.
Jim is considering two ways of financing the firm: (a)60% equity financing and 40% debt at 14%,or (b)100% equity financing.He can sell common stock to his relatives for $10 per share.Either way,he will need to raise $800,000.
A)Compute his break-even point in dollars.
B)Calculate the Degree of Operating Leverage at the expected first-year sales volume.
C)Calculate the Degree of Financial Leverage and the Degree of Combined Leverage under each of the possible financing plans.
D)Explain the implications of your answers if the machine shop business is highly cyclical.

• A)Compute his break-even point in dollars.
• B)Calculate the Degree of Operating Leverage at the expected first-year sales volume.
• C)Calculate the Degree of Financial Leverage and the Degree of Combined Leverage under each of the possible financing plans.
• D)Explain the implications of your answers if the machine shop business is highly cyclical.

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Definitions:

Business Firms

Business firms are entities that engage in professional, commercial, or industrial activities with the aim of generating profits from their operations.

Housing Market

The market segment covering the buying, selling, and renting of residential properties.

Housing Prices

The amount of money required to purchase residential properties, reflecting both the demand for and the supply of homes.

Bubble

An increase in the price of a good based not on the fundamentals of demand or value, but instead on a belief that the price will keep going up.