Corporate Finance - Corporate Finance Section 2
36. The cost of equity capital is equal to the:
- Option : C
- Explanation : Using the sustainable growth calculation, the growth rate is calculated as: g = (1 – Dividend payout ratio) (Return on Equity) = (1 – 0.35) (15%) = 9.8% Re = (D1 / P0) + g = ($2.00 / $40) + 9.80% = 14.75%.
- Option : C
- Explanation : DOL = (quantity * contribution margin) / [(quantity * contribution margin) – fixed costs] DOL (100,000 units) =($12 * 100,000) / [($12 * 100,000) – 600,000] = 2.00 DOL (200,000 units) = ($12 * 200,000) / [($12 * 200,000) – 600,000] = 1.33 DOL (300,000 units) = ($12 * 300,000) / [($12 * 300,000) – 600,000] = 1.20 The DOL is lowest at the 300,000 unit production level.
| Sales in 2009 | 22.5 million computers |
| Average price per computer | Rs.90,000 |
| Fixed costs for the period | Rs.33 billion |
| Variable costs per computer | Rs.70,000 |
What is the degree of operating leverage (DOL)
- Option : B
- Explanation : DOL = [Q (P - V)] / [Q (P - V) - F] =[22.5 million (Rs.90,000 – Rs.70,000)] / [22.5 million (Rs.90,000 – Rs.70,000) – 33 billion] = 1.08 For a 10 percent increase in computers sold, operating income increases by 1.08 * 10% = 10.08%.
40. Degree of operating leverage is best described as a measure of the sensitivity of:
- Option : C
- Explanation : The degree of operating leverage is the elasticity of operating earnings with respect to the number of units produced and sold. As elasticity, the degree of operating leverage measures the sensitivity of operating earnings to a change in the number of units produced and sold.
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