"CP 4-2. (Continued)Adams CorporationCost of Goods Sold Unit Cost per thousand Unit cost per thousandst st before January 1 after January 1Material .............$52 $60Labor .................20 20Overhead ...........10 10 $82 $90Ending inventory as of December 31 was 2,900,000, therefore, sales forJanuary and February had a cost of goods sold per thousand units of $82,and March sales reflect the increased cost of $90 per thousand unitsusing FIFO inventory methods.Pro Forma Balance Sheet (March)AssetsLiabilities & Stockholders' EquityCurrent Assets:Current Liabilities: Cash ...........................$ 25,000 Accounts Payable $ 150,000Accounts Receivable 310,000 Notes Payable 47,380Inventory ...................405,000 Long-Term Debt 400,000Stockholders' Equity: Plant & Equip:800,000 Common Stock 504,200Retained Earnings 438,420Total AssetsTotal Liabilities & $1,540,000 Stockholders' Equity $1,540,000S4-48 CP 4-2. (Continued)Explanation of Changes in the Balance Sheet:Cash = ending cash balance from cash budget in MarchAccounts receivable =$217,000all of March sales 93,000plus 50% of Feb. $310,000salesInventory = ending inventory in March of 4,500,000 units at $90 perthousandPlant and equipment did not change since we did not includedepreciation.RE = Old RE + (NI - dividends) - = $390,000 + ($96,840 $48,240) = $438,420 S4-49 WEB EXERCISEThe Borders Group was discussed at the beginning of the chapter as a company in transition. Go to www.bordersgroupinc.com.1. Click on “About Us.” In two paragraphs, write a summary of the company profile.2. Then click on “Investors.”3. Then click on stock chart. How has the stock been performing over the last 12 months.4. Then click on “Press Releases.” Click on the press release that covers Borders’ most recentquarterly (Q) performance. Generally speaking, how well has the company been doing?Note: From time to time, companies redesign their Web sites and occasionally a topic wehave listed may have been deleted, updated, or moved into a different location. If you clickon the site map or site index, you will be introduced to a table of contents which should aidyou in finding the topic you are looking for.S4-50 Chapter 5Discussion Questions5-1. Discuss the various uses for break-even analysis.Such analysis allows the firm to determine at what level of operations itwill break even (earn zero profit) and to explore the relationship betweenvolume, costs, and profits. 5-2. What factors would cause a difference in the use of financial leverage for autility company and an automobile company?A utility is in a stable, predictable industry and therefore can afford to usemore financial leverage than an automobile company, which is generallysubject to the influences of the business cycle. An automobile manufacturermay not be able to service a large amount of debt when there is a downturnin the economy. 5-3. Explain how the break-even point and operating leverage are affected bythe choice of manufacturing facilities (labor intensive versus capitalintensive).A labor-intensive company will have low fixed costs and a correspondinglylow break-even point. However, the impact of operating leverage on thefirm is small and there will be little magnification of profits as volumeincreases. A capital-intensive firm, on the other hand, will have a higherbreak-even point and enjoy the positive influences of operating leverage asvolume increases. 5-4. What role does depreciation play in break-even analysis based onaccounting flows? Based on cash flows? Which perspective is longer termin nature?For break-even analysis based on accounting flows, depreciation isconsidered part of fixed costs. For cash flow purposes, it is eliminated fromfixed costs.The accounting flows perspective is longer-term in nature because we mustconsider the problems of equipment replacement. S5-1 5-5. What does risk taking have to do with the use of operating and financialleverage?Both operating and financial leverage imply that the firm will employ aheavy component of fixed cost resources. This is inherently risky becausethe obligation to make payments remains regardless of the condition of thecompany or the economy. 5-6. Discuss the limitations of financial leverage.Debt can only be used up to a point. Beyond that, financial leverage tendsto increase the overall costs of financing to the firm as well as encouragecreditors to place restrictions on the firm. The limitations of using financialleverage tend to be greatest in industries that are highly cyclical in nature. 5-7. How does the interest rate on new debt influence the use of financialleverage?The higher the interest rate on new debt, the less attractive financialleverage is to the firm. 5-8. Explain how combined leverage brings together operating income andearnings per share.Operating leverage primarily affects the operating income of the firm. Atthis point, financial leverage takes over and determines the overall impacton earnings per share. A delineation of the combined effect of operatingand financial leverage is presented in Table 5-6 and Figure 5-5. 5-9. Explain why operating leverage decreases as a company increases salesand shifts away from the break-even point.At progressively higher levels of operations than the break-even point, thepercentage change in operating income as a result of a percentage changein unit volume diminishes. The reason is primarily mathematical — as wemove to increasingly higher levels of operating income, the percentagechange from the higher base is likely to be less. 5-10. When you are considering two different financing plans, does being at thelevel where earnings per share are equal between the two plans alwaysmean you are indifferent as to which plan is selected?The point of equality only measures indifference based on earnings per share.Since our ultimate goal is market value maximization, we must also beconcerned with how these earnings are valued. Two plans that have the sameearnings per share may call for different price-earnings ratios, particularlywhen there is a differential risk component involved because of debt.S5-2 "