Two Finance Questions Set

Question 2:

Aardvark Manufacturing is evaluating two different operating structures which are described below. The firm has annual interest expense of $250, common shares outstanding of 1,000, and a tax rate of 40 percent.

a) For each operating structure, calculate

(a1) EBIT and EPS at 10,000, 20,000, and 30,000 units.

(a2) the degree of operating leverage (DOL) and degree of total leverage (DTL) using 20,000 units as a base sales level.

(a3) the operating breakeven point in units.

(b) Which operating structure has greater operating leverage and business risk?

(c) If Aardvark projects sales of 20,000 units, which operating structure is recommended?

Question 2

Amarillo’s Best Company (ABC) has released the following information.

(a) What are ABC's current earnings per share?

(b) What is ABC's current P/E ratio?

(c) ABC wants to use half of its earnings either to pay shareholders dividends or to repurchase shares for inclusion in the firm's employee stock ownership plan. If the firm pays a cash dividend, what will be the dividend per share received by existing shareholders?

(d) Instead of paying the cash dividend, what if the firm uses half of its earnings to pay $55 per share to repurchase the shares, what will be the firm's new EPS? What should be the firm's new share price?

(e) Compare the impact of a stock dividend and stock repurchase on shareholder wealth.