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: Suppose revenues fall by $300. What is the per cent change in profit with and without the debt? Assume that the total variable productions costs remain the same.
A) 64.5%, 60%
B) 60%, 64.5%
C) 59.2%, 40.8%
D) 40.8%, 59.2%

Question

Quizplus · Accepted Answer

Without debt, the profit change is calculated by the change in revenue minus the change in COGS and SG&A. With debt, the interest expense affects the profit change. The calculations show a 60% change without debt and a 64.5% change with debt.

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