BWP projects sales of 100,000 units next year at an average price of $50 per uni
ID: 2382931 • Letter: B
Question
BWP projects sales of 100,000 units next year at an average price of $50 per unit. Variable costs are estimated at 40% of revenue, and fixed costs will be $2.4 million. BWP has $1 million in bonds outstanding on which it pays 8%, and its marginal tax rate is 39%. There are 100,000 shares of stock outstanding which trade at their book value of $30.
BWP intends to purchase a machine that will result in a major improvement in product quality along with a small increase in manufacturing efficiency. The machine will cost $1 million, which will be borrowed at 9%. The quality improvement is expected to have a significant impact on BWP's competitive position. Indeed, management expects sales to increase by 5% in spite of a planned 10% price increase. The efficiency improvement combined with the price increase will result in variable costs of 36% of revenue. Fixed cost, however, will rise by 19%. Compute BWP's, new contribution, contribution margin, Net Income, DOL and EPS if it purchases the new machine. Round the answers to two decimal places. Enter your Net income answer in whole dollars. For example, an answer of $1.2 million should be entered as 1,200,000, not 1.2.
Explanation / Answer
Contribution per unit= Selling Price per unit - Variable Cost per unit
Expected Sales increase= 5% of 1,00,000 units = 5000 units; hence new projected sales post proposed purchase of new machine= 1,05,000 units
New Price post planned price increase= $50+ 10% of $50= $50+$5= $55 per unit
New projected revenue= 1,05,000 units * $55 per unit= $57,75,000
New estimated Variable Cost= 36% of $57,75,000= $20,79,000
New Variable Cost per unit= $20,79,000 / 1,05,000 units= $19.80 per unit
New Fixed Cost= $24,00,000 + 19% of $24,00,000= $24,00,000 + $4,56,000 = $28,56,000
New Contribution per unit= $55.00 per unit - $19.80 per unit= $35.20 per unit
Contribution Margin= New Contribution per unit / New Selling Price per unit= $35.20 per unit / $55 per unit
= 64%
Net Income [Net Profit]= New Projected Revenue - New total Variable Costs- New total Fixed Costs - Interest Expense on existing outstanding Bonds of $1 million @ 8% p.a. - Interest Expense on new borrowing of $1 million @ 9% p.a.- Depreciation on new machine - Corporate Taxation @39%
= $57,75,000 - $20,79,000 - $28,56,000 - (8% of $10,00,000) - (9% of $10,00,000) - Depreciation on new machine of $10,00,000 - Corporate Taxation @39%
Depreciation information is not provided; hence we cannot proceed to get actual answers for Net Income [Net Profit] and EPS [Earnings Per Share]
DOL [i.e. Degree of Operating Leverage] = [% Change in EBIT / % Change in Sales]
In the absence of information about Depreciation on new machine and on existing machines, EBIT cannot be calculated and hence DOL also cannot be calculated..
DOL [i.e. Degree of Operating Leverage] actually indicates proportion of Total Fixed Costs of a financial year to Total Costs of the financial year comprising Total Fixed Cost plus Total Variable Costs
EPS [Earnings Per Share]= Net Income for financial year / Total number of outstanding equity shares.
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