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A New Firm Is Developing Its Business Plan

question 68

Multiple Choice

A new firm is developing its business plan.It will require $615,000 of assets (which equals total invested capital) ,and it projects $450,000 of sales and $355,000 of operating costs for the first year.Management is reasonably sure of these numbers because of contracts with its customers and suppliers.It can borrow at a rate of 7.5%,but the bank requires it to have a TIE of at least 4.0,and if the TIE falls below this level the bank will call in the loan and the firm will go bankrupt.The firm will use only debt and common equity for financing.What is the maximum debt to capital ratio (measured as debt/total invested capital) the firm can use? (Hint: Find the maximum dollars of interest,then the debt that produces that interest,and then the related debt to capital ratio.)

Definitions:

Cost Behaviour

The way in which a cost changes or reacts in relation to changes in business activity levels.

Variable Selling Expenses

Sales-related costs that vary directly with the volume of sales, such as commissions and shipping charges.

Contribution Approach

An income statement format that organizes costs by their behavior. Costs are separated into variable and fixed categories rather than being separated according to organizational functions.

Variable Administrative Expenses

Costs that fluctuate in relation to a company's activity levels, such as clerical support and utilities.