Outflung Computers has $1,000 in revenue this year, along with COGS of $400 and SG&A of $100. The required rate of return on its equity is 14%, and the risk-free rate is 5%. Assume that the COGS only includes the marginal costs of selling a computer. Banana is considering adding $700 worth of debt with a coupon rate of 5% and a YTM of 7.9% to its capital structure. M&M Proposition 2: What per cent of the company's costs are fixed, and what per cent are variable with the debt and without the change in leverage?
A) 27.9%, 72.1%
B) 72.1%, 27.9%
C) 25.23, 74.77%
D) 74.77%, 25.23%

Question

Quizplus · Accepted Answer

The COGS of $400 is variable, as it includes only the marginal costs. SG&A of $100 is fixed. Without the debt, the total costs are $500, with $100 fixed (20%) and $400 variable (80%). With the debt, the interest cost is $700 * 5% = $35, making total costs $535, with $135 fixed (25.23%) and $400 variable (74.77%).

Outflung Computers Has $1,000 in Revenue This Year, Along with COGS