Introduction to Finance

c. 
What will be the expected level of EBIT and net income if next 
year’s sales fall 20 percent?
7. 
Here are the income statements for Genatron Manufacturing 
Corporation for 2016 and 2017:
Income Statement
2016
2017
Net sales 
$1,300,000 
$1,500,000
Cost of goods sold 
780,000 
900,000
Gross profit 
$520,000 
$600,000
General and administrative 
150,000 
150,000
Marketing expenses 
130,000
150,000
Depreciation 
40,000 
53,000
Interest 
45,000 
57,000
Earnings before taxes 
$155,000 
$190,000
Income taxes 
62,000 
76,000
Net income 
$93,000 
$114,000
Assuming one-half of the general and administrative expenses are fi xed 
costs, estimate Genatron’s DOL, DFL, and DCL in 2016 and 2017.
8. 
The Nutrex Corporation wants to calculate its WACC. Its target 
capital structure weights are 40 percent long-term debt and 60 per-
cent common equity. The before-tax cost of debt is estimated to be 
10 percent and the company is in the 40 percent tax bracket. The cur-
rent risk-free interest rate is 8 percent on Treasury bills. The expected 
return on the market is 13 percent and the fi rm’s stock beta is 1.8.
a. 
What is Nutrex’s cost of debt?
b. 
Estimate Nutrex’s expected return on common equity using the 
security market line (SML).
c. 
Calculate the after-tax WACC.
9. 
The following are balance sheets for the Genatron Manufacturing 
Corporation for the years 2016 and 2017:
Balance Sheet
2016
2017
Cash 
$50,000 
$40,000
Accounts receivable 
200,000
260,000

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Problems
597
Inventory 
450,000 
500,000
Total current assets 
700,000 
800,000
Fixed assets (net) 
300,000 
400,000
Total assets 
$1,000,000 
$1,200,000
Bank loan, 10% 
$90,000 
$90,000
Accounts payable 
130,000 
170,000
Accruals 
50,000 
70,000
Total current liabilities 
$270,000 
$330,000
Long-term debt, 12% 
300,000 
400,000
Common stock, $10 par 
300,000 
300,000
Capital surplus 
50,000 
50,000
Retained earnings 
80,000 
120,000
Total liabilities and equity 
$1,000,000 
$1,200,000
a. 
Calculate the WACC based on book value weights. Assume an 
after-tax cost of new debt of 8.63 percent and a cost of common 
equity of 16.5 percent.
b. 
The current market value of Genatron’s long-term debt is 
$350,000. The common stock price is $20 per share and 30,000 
shares are outstanding. Calculate the WACC using market value 
weights and the component capital costs in (a).
c. 
Recalculate the WACC based on book value and market value 
weights assuming the before-tax cost of debt will be 18 percent, the 
company is in the 40 percent income tax bracket, and the after-tax 
cost of common equity capital is 21 percent.
10. 
The Basic Biotech Corporation wants to determine its WACC. 
Its target capital structure weights are 50 percent long-term debt and 
50 percent common equity. The before-tax cost of debt is estimated to 
be 10 percent, and the company is in the 30 percent tax bracket. The 
current risk-free interest rate is 8 percent on Treasury bills (T-bills). 
The after-tax cost of common equity capital is 14.5 percent. Calculate 
the after-tax weighted average cost of capital.