"5-25. Solution:Highland Cable Companya. At break-even before expansion:PQ = FC + VCwhere PQ equals sales volume at break-even point Sales = Fixed costs + Variable costs(Variable costs = 50% of sales) Sales = $1,500,000 + .50 sales.50 sales = $1,500,000 Sales $3,000,000 = At break-even after expansion:Sales = $1,900,000 + .50 sales .50 sales = $1,900,000Sales $3,800,000 = b. Degree of operating leverage, before expansion, at sales of$4,000,000Q P - VC ( ) S - TVC DOL = = Q P-- VC FC S- TVC- FC ( ) $4,000,000 - $2,000,000 =$4,000,000- $2,000,000- $1,500,000 $2,000,000 = = 4x 500,000 S5-38 5-25. (Continued)Degree of operating leverage after expansion at sales of$5,000,000$5,000,000 - $2,500,000 DOL = $5,000,000-- $2,500,000 $1,900,000 $2,500,000 = = 4.17x $600,000 This could also be computed for subsequent years.c. DFL before expansion:EBIT DFL =EBIT -1 Compute EBIT Sales $4,000,000 –TVC 2,000,000 –FC 1,500,000 EBIT $ 500,000 I = $ 140,000$500,000 $500,000 = = =1.39x$500,000 - $140,000 $360,000 S5-39 5-25. (Continued)DFL after expansion:EBIT DFL = EBIT - I Compute EBIT and I for all three plans: (50% Debt(100% Debt) (100% Equity) and Equity)(1) (2) (3)Sales $5,000,000 $5,000,000 $5,000,000–TVC 2,500,000 2,500,000 2,500,000–FC 1,900,000 1,900,0001,900,000EBIT $600,000 $600,000 $600,000I – Old Debt 140,000 140,000 140,000I – New Debt 260,000 0120,000Total Interest $400,000 $ 140,000 $260,000EBIT DFL = EBIT - I (1) (2) (3)$600,000 $600,000 $600,000 $600,000--- $400,000 $600,000 $140,000 $600,000 $260,000 ( ) ( ) ( ) DFL = 3x 1.30x 1.76xS5-40 5-25. (Continued)d. EPS @ sales of $5,000,000(refer back to part c to get the values for EBIT and Total I) (50% Debt(100% Debt) (100% Equity) and(1) (2) Equity) (3)EBIT $600,000 $600,000 $600,000Total Interest 400,000 140,000 260,000EBT $200,000 $460,000 $340,000Taxes (30%) 60,000 138,000 102,000EAT $140,000 $322,000 $238,000Shares (old) 200,000 200,000 200,000Shares (new) 0 100,000 40,000Total Shares 200,000 300,000 240,000EPS(EAT/Totalshares) $.70 $1.07 $.99S5-41 EPS @ sales of $9,000,000 (50% Debt(100% Debt) (100% Equity) and Equity)(1) (2) (3)Sales $9,000,000 $9,000,000 $9,000,000–TVC 4,500,000 4,500,000 4,500,000–FC 1,900,000 1,900,000 1,900,000EBIT $2,600,000 $2,600,000 $2,600,000Total Interest400,000140,000260,000EBT $2,200,000 $2,460,000 $2,340,000Taxes(30%)660,000738,000702,000EAT $1,540,000 $1,722,000 $1,638,000Total Shares 200,000 300,000 240,000EPS (EAT/TotalShares) $7.70 $5.74 $6.83e. In the first year, when sales and profits are relatively low,plan 2 (100% equity) appears to be the best alternative.However, as sales expand up to $9 million, financial leveragebegins to produce results as EBIT increases and Plan 1(100% debt) is the highest yielding alternative.S5-42 "