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Team D1 Case 3

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2015SP1-FIN-65151X-01 / Accounting & Finance / Professor Francois Silatchom

MODULE 3

POWERLINE NETWORK CORP.

Operating Leverage, Financial Leverage, and the Optimal Capital Structure

TEAM D1
Laura Hamin – lhny86@nycap.rr.com
Raymond Negron – ffnegron@hotmail.com
Eulises Roman – ermediaus@aol.com
Myeshia Wagner – mrs.wagner1982@yahoo.com

Table of Contents
Executive Summary 3
Introduction 3
Analysis 4
Figure 1: Risk Comparison between Plans L and H 4
Figure 2: Operating probability under Plan L and H 5
Figure 3: Expected ROIC under plan L 5
Figure 4: Expected ROIC under plan H 6
Figure 5: Expected EBIT, NOPAT and future Cash Flows 7
Figure 6: Effects of the Financial Leverage on ROE 8
Figure 7: WACC and TIE Calculations 9 …show more content…

Business risk refers to the chance a business's cash flows are not enough to cover its operating expenses like cost of goods sold, rent and wages. Unlike financial risk, business risk is independent of the amount of debt a business owes (Guzman & Media, 2015). Financial risk refers to the chance a business's cash flows are not enough to pay creditors and fulfill other financial responsibilities (Guzman & Media, 2015). Financial risk is the additional business risk concentrated on common stockholders when financial leverage is used and depends on the amount of debt and preferred stock financing (Brigham & Ehrhardt, 2014).

Based on the data provided on Table 1, Figure1: Risk Comparison between Plans L and H, demonstrates risk between Plans L and H is. The EBIT represents one key variable of measuring business risk, since this risk comes from the level of the operations in a firm when it uses no debt.
Figure 1: Risk Comparison between Plans L and H
Plan L
Plan H
Low fixed costs
$400,000
High Fixed costs
$2,800,000
High variable cost/Unit
$329
Low variable cost/Unit
$150
Small capital required
$1,500,000
Large capital required
$400,000,000
Small units of capacity
20,000
Large units of capacity
35,000

Figure 2: Operating probability under Plan L and H demonstrates Operating leverage under each plan – the EBIT Calculation. Operating leverage is the

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