Red Sunset Co. manufactures mobile phones and wants to add a new model to its current line of products. The firm has estimated that the new phone’s selling price will be $80 and that variable costs would represent 65% of the sale price. Fixed operating costs are estimated to be $15M and the firm’s marginal tax rate is expected to remain at 35%. The firm also has forecasted that interest expenses associated with the new chip will reach $5M. The firm has 5M of common shares outstanding and forecasts a total preferred dividend payment of $200,000 for the next year. If Red Sunset Co. expects to sell 1M units of the new phone, then:
a) Create an income statement with the previous information.
b) Calculate the operating break-even point in both units and dollars.
c) How many units would Red Sunset Co. need to sell in order to achieve earnings, before interest and taxes of $2M?
d) Calculate the degree of operating, financial, and combined leverage.
e) Use the Goal Seek tool to determine the number of units that would allow Red Sunset Co. to break even in terms of its net income and the selling price to break even in terms of earnings before taxes. Also, determine with the same tool how much preferred dividends the firm would need to pay to keep a degree of financial leverage of 2.
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