QUESTION 4 - LEVERAGE & CAPITAL STRUCTURE A manufacturing company produces a product that sells for $12.00 per unit. Each unit of output has a variable cost of $4.00. Fixed operating costs are $180,000 per year. The firm has a $550,000 bond that pays 10% interest annually, and 12% irredeemable preferred stock with a par value of $2, that has 100,000 outstanding shares. The firm currently sells approximately 110,000 blocks per year, and is taxed at a rate of 30%.

Please answer the following questions:

a. Calculate the bond interest incurred and the preferred stock dividend paid (3 marks)

b. On the basis of the firm's current sales of 110,000 units per year, calculate its Earnings Before Interest and Taxes (EBIT), and Earnings Available to Common Stockholders (EACS) (3 marks)

c. Calculate the firm's Degree of Operating Leverage (DOL) (2 marks)

d. Calculate the firm's Degree of Financial Leverage (DFL) (2 marks)

e. Calculate the firm's Degree of Total Leverage (DTL) (2 marks)

f. The manufacturing company is anticipating an increased demand of approximately 50,000 units in the coming year. Predict the impact of this increase in output on the firm's EBIT and Earnings Available to Common Stockholders (EACS). (Note: Use the DOL, DFL and DTL to describe the impact of the change in production). (4 marks)

g. Discuss whether decreasing the proportion of debt relative to equity can lead to a reduction in its cost of capital and hence an increase in the value of the company (i.e. allow the firm to achieve its optimal capital structure) (4 marks)