Your Girlfriend Plans to Start a New Company to Make

question 28

Multiple Choice

Your girlfriend plans to start a new company to make a new type of cat litter. Her father will finance the operation, but she will have to pay him back. You are helping her, and the issue now is how to finance the company, with equity only or with a mix of debt and equity. The price per unit will be $10.00 regardless of how the firm is financed. The expected fixed and variable operating costs, along with other information, are shown below. How much higher or lower will the firm's expected EPS be if it uses some debt rather than only equity, i.e., what is EPSL ? EPSU? $\begin{array}{lrr}&\underline{0 \% \text { Debt, U }} &\underline{60 \% \text { Debt, }}\\\text { Expected unit sales } & 225,000 & 225,000 \\\text { Price per unit } & \$ 10.00 & \$ 10.00 \\\text { Fixed costs } & \$ 1,000,000 & \$ 1,000,000 \\\text { Variable cost/unit } & \$ 3.50 & \$ 3.50 \\\text { Required investment } & & \\\text { Shares issued at } \$ 10 / \text { share } & \$ 2,500,000 & \$ 2,500,000 \\\text { \% Debt } & 250,000 & 100,000 \\\text { Debt, \$ } & 0.00 \% & 60.00 \% \\\text { Equity, \$ } & \$ 0 & \$ 1,500,000 \\\text { Interest rate } & \$ 2,500,000 & \$ 1,000,000 \\\text { Tax rate } & \text { NA } & 10.00 \% \\& 35.00 \% & 35.00 \%\end{array}$

• A) $0.54
• B) $0.60
• C) $0.67
• D) $0.75
• E) $0.83

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Definitions:

Total Manufacturing Costs

The aggregate cost incurred in the production of goods, including raw materials, labor, and overhead expenses.

Direct Labor

The cost of labor that is directly involved in the production of goods or services.

Manufacturing Overhead

Refers to the indirect factory-related costs incurred when manufacturing a product or performing a service, which may include the cost of utilities, depreciation, and salaries of maintenance personnel.

Total Manufacturing Costs

The sum of all costs directly involved in the production of a good, including direct materials, direct labor, and manufacturing overhead.