Introduction to Finance

3. 
Stern’s Stews Inc. is considering a new capital structure. Its current 
and proposed capital structures are the following:
Current
Proposed
Total assets 
$150 million
$150 million
Debt 
25 million 
100 million
Equity 
125 million 
50 million
Common stock price 
$50 
$50
Number of shares 
2,500,000 
1,000,000
Interest rate 
12% 
12%
Stern’s Stews’ president expects next year’s EBIT to be $20 million, but 
it may be 25 percent higher or lower. Ignoring taxes, perform an EBIT/
eps analysis. What is the indiff erence level of earnings before interest 
and taxes? Should Stern’s Stews change its capital structure? Why?
4. 
Faulkner’s Fine Fries Inc. (FFF) is thinking about reducing its debt 
burden. Given the following capital structure information and an 
expected EBIT of $50 million (plus or minus 10 percent) next year, 
should FFF change their capital structure?
Current
Proposed
Total assets 
$750 million 
$750 million
Debt
450 million 
300 million
Equity 
300 million 
450 million
Common stock price
$30 
$30
Number of shares 
10,000,000 
15,000,000
Interest rate 
12% 
12%
5. 
Redo Problem 4, assuming the less-leveraged capital structure will 
result in a borrowing cost of 10 percent and a common stock price 
of $40.
6. 
A fi rm has sales of $10 million, variable costs of $4 million, fi xed 
expenses of $1.5 million, interest costs of $2 million, and a 30 percent 
average tax rate.
a. 
Compute its DOL, DFL, and DCL.
b. 
What will be the expected level of EBIT and net income if next 
year’s sales rise 10 percent?