FINANCIAL ANALYSIS: TOOLS AND TECHNIQUES CHAPTER 6 pot

Depending on the pro-portion of fixed versus variable costs in the company’s cost structure, the total in-cremental contribution from additional units can result in a sizable overall jum

DYNAMICS AND GROWTH

OF THE BUSINESS SYSTEM

and described in broad terms the interrelationship of decisions, financial sticks, and management policies used in the pursuit of shareholder value creation

yard-In the previous three chapters, we dealt with several specific aspects of financialmanagement: the movement of cash through the system, the evaluation of the fi-nancial results of the system, and the projection of future financial requirements

We ended Chapter 5 with a broad description of financial modeling as a valuableassist in developing financial projections, after demonstrating basic pro forma andcash budgeting processes as common tools for financial planning Now we need

to return to our systems concept and become more specific about how some of thesystem’s internal characteristics and dimensions affect changes in the cash flowpatterns that lead to shareholder value creation

There are two important subjects that so far we’ve touched on only briefly,but that are an integral part of understanding and modeling the business system,namely leverage and the potential for growth The reader will recall that financialleverage and the funding potential with which to support growth were represented

in the financing sector of the business system diagram We also recognized the terplay of fixed and variable costs in the operational sector At the time we brieflyindicated the trade-offs and choices that could be made by management in dealingwith these areas Now it’s time to integrate these concepts into a more thoroughfinancial planning discussion that deals with the operational and policy driversunderlying the pro forma statements and cash budgets covered in the previouschapter

in-We’ll focus first on the concept of leverage—the impact of fixed elements

on overall results—in two critical areas:

Here we’ll explore in detail the impact of volume changes on profitabilityunder a variety of assumptions about the nature and level of fixed elements in thecompany’s cost pattern, and deal with their implications for structuring and man-aging the operational part of the system Then we’ll illustrate the impact of finan-cial leverage on a company’s profitability, and how the introduction of fixedinterest charges into the financial system can both benefit a company’s return andmagnify the variability of these returns, based on a trade-off of risk versus return.Last, we’ll turn to an integrated modeling approach that’ll demonstrate thedrivers of growth in the system and their financial implications Our focus will be

on testing the financial impact of top-level policy changes in investment, tions, and financing The vehicle for this process will be a basic financial growthplan format, which in a highly summarized way allows us to visualize the inter-relationship of the key financial dimensions and drivers affecting the performanceand growth of the total business system We’ll cover the following concepts indetail:

opera-• The basic financial growth model

• Determining sustainable and affordable growth

• The integrated financial plan

The reader is encouraged to revisit the first section of Chapter 2, which scribes the business system and its key linkages, many of which we’ll test in thisdiscussion The broader concept of shareholder value creation will be dealt withextensively in Chapter 12

un-profit Similarly, financial leverage occurs when a company’s capital structure

contains obligations with fixed interest rates Earnings after interest and return onequity are boosted or depressed more than proportionally as volume and profit-ability fluctuate However, there are differences in the specific elements involvedand in the methods of calculation of each type of leverage Both operating and fi-nancial leverage can be present in any business, depending on the choices made

by management in structuring operations and the financing requirements, and therespective impact on net profit will tend to be mutually reinforcing We need tounderstand the specific impact of leverage whenever it’s encountered in a busi-ness, as it is an important element in the financial planning process

Operating Leverage

Distinguishing between fixed and variable costs (those costs that vary with timeand those that vary with the level of activity) is an old idea This separation of

costs by behavior is the basis for break-even analysis The idea of “breaking even”

is based on the simple question of how many units of product or service a businessmust sell in order to cover its fixed costs before beginning to make a profit Pre-sumably, unit prices are set at a level high enough to recoup all direct (that is, vari-able) unit costs and leave a margin of contribution toward fixed (period) costs andprofit Once sufficient units have been sold to accumulate the total contributionneeded to offset all fixed costs, the margin from any additional units sold will be-come profit—unless a new layer of fixed costs has to be added at some futurepoint to support the higher volume

Understanding this principle will improve our insight into how the tional aspects of a business relate to financial planning and projections Thisknowledge is also helpful in setting operational policies, which, especially in avolatile business setting might, for example, focus on minimizing fixed coststhrough outsourcing certain activities But in a broader sense, it’ll allow us to ap-preciate the distorting effect which significant operating leverage might exert onthe measures and comparisons used in financial analysis

opera-A word of caution must be added here There’s nothing absolute about theconcept of fixed costs, because in the long run, every cost element becomes vari-able All costs rise or fall as a consequence of management policies and decisions,and can therefore be altered As a result, the break-even concept must be handledwith flexibility and judgment

As we mentioned, introducing fixed costs to the operations of a businesstends to magnify profits at higher levels of operation up to the point when anotherlayer of fixed costs might be needed to support greater volume This is due to thebuildup of incremental contribution which each additional unit provides over andabove the strictly variable costs incurred in producing it Depending on the pro-portion of fixed versus variable costs in the company’s cost structure, the total in-cremental contribution from additional units can result in a sizable overall jump

in profit

Analyzing a leveraged operating situation is quite straightforward Once allfixed costs have been recovered through the cumulative individual contributionsfrom a sufficient number of units, profits begin to appear as additional units aresold Profits will grow proportionally faster than the growth in unit volume Un-fortunately, the same effect holds for declining volumes of operations, which re-sult in a profit decline and accelerating losses that are disproportional to the rate

of volume reduction Operating leverage is definitely a double-edged sword!

We can establish the basic definitions as follows:

The formal way of describing leverage conditions is quite simple We’re

in-terested in the effect on profit (I) of changes in volume (V) The elements that bear

on this are the unit price (P), unit variable costs (C), and fixed costs (F) The

to the constant element, namely fixed costs

change in volume will equal the total change in profit Under normal conditions,

the constant, fixed costs (F) will remain just that The relative changes in profit for

a given change in volume will be magnified because of this fixed element.Another way of stating the leverage relationships is to use profit as a percent

of sales (s), one of the ratios developed in Chapter 4 Using the previous notation,

s

and defining I in terms of the components, the formula becomes:

s and slightly rewritten:

s The relationship indicates that the profit/sales ratio depends on the contri-bution per unit of sales, less fixed costs as a percent of sales revenue We observethat, to the extent fixed costs are present, they cause a reduction in the profit ratio

The larger F is, the larger the reduction Any change in volume, price, or unit cost, however, will tend to have a disproportional impact on s because F is constant.

Now let’s examine how the process works, using some concrete examples.We’ll use the cost/profit conditions of a simple business with relatively high fixedcosts of $200,000 in relation to its volume of output and variable costs per unit.The fixed costs are largely overhead and costs related to owning and operating theproduction facilities, including the depreciation effect Our company has a maxi-mum level of production of 1,000 units, and for simplicity, we assume there’s nolag between production and sales Units sell for $750 each, and variable costs ofmaterials, labor, and supplies amount to $250 per unit Every unit therefore pro-vides a contribution of $500 toward fixed costs and profit

1C PVP F

V(P  C )  F VP I VP

Figure 6–1’s break-even chart is a simple representation of the conditions

just outlined At zero volume, fixed costs amount to $200,000, and they remainlevel as volume is increased until full capacity has been reached Variable costs,

on the other hand, accumulate by $250 per unit as volume is increased until a level

of $250,000 has been reached at capacity, for a total cost of $450,000 Revenuerises from zero, in increments of $750, until total revenue has reached $750,000

Total revenue

– Price of $750/unit

Variable costs of $250/unit

$800 700 600 500 400 300 200 100

Break-even volume 400 units

Profits

Break-even point

Fixed costs of $200,000

Losses

100 200 300 400 500 600 700 800 900 1,000

$750 250

$500

Profits and Losses as a Function of Volume Changes of 25 Percent

196 Financial Analysis: Tools and Techniques

the total cumulative revenue of $300,000 at that point is just sufficient to offset thefixed costs of $200,000, plus the total variable costs of $100,000 (400 units at

$250 each) If operations increase beyond this point, profits are generated; at umes of less than 400 units, losses are incurred The break-even point can befound numerically, of course, by simply dividing the total fixed costs of $200,000

vol-by the unit contribution of $500, which results in 400 units, as we expected:

The most interesting aspect of the break-even chart, however, is the cleardemonstration that increases and decreases in profit are not proportional A series

of 25 percent increases in volume above the break-even point will result in muchlarger percentage jumps in profit growth

The relevant change data are displayed in the table under the chart Theyshow a gradual decline in the growth rate of profit from infinite to 51 percent.Similarly, as volume decreases below the break-even point in 25 percent decre-ments, the growth rate of losses goes from infinite to a modest 18 percent, as

volume approaches zero Thus, changes in operations close to the break-even point, whether up or down, are likely to produce sizable swings in earnings.

Changes in operations well above or below the break-even point will cause lesserfluctuations

We must be careful in interpreting these changes, however As in any centage analysis, the specific results depend on the starting point and on the rela-tive proportions of the components In fact, managers will generally be muchmore concerned about the total dollar amount of change in profit than about per-centage fluctuations Moreover, it’s easy to exaggerate the meaning of profit fluc-tuations unless they are viewed carefully in the context of a company’s total coststructure and its normal level of operations

per-Nevertheless, the concept should be clear: The closer to its break-even point

a firm operates, the more dramatic will be the profit impact of volume changes.The analyst assessing a company’s performance or making financial projectionsmust attempt to understand where the level of its current operations is relative tonormal volume and the break-even point, and then interpret the analytical resultsaccordingly

Clearly, the greater the relative level of fixed costs, the more powerful theeffect of operating leverage becomes Therefore, we need to understand this as-pect of the company’s cost structure In capital-intensive industries, such as steel,mining, forest products, and heavy manufacturing, most of the costs of productionare indeed fixed for a wide range of volumes This tends to accentuate profitswings as companies move away from break-even operations

Another example is the airline industry, which from time to time tially increases the capacity of its flight equipment The fixed costs associated

with leasing and operating these expensive aircraft initially cause sharp drops inprofit for many airlines As business and private travel rise to approach the newlevels of capacity, well-managed airlines experience dramatic improvements inprofits, while marginal performers continue to suffer losses In contrast, serviceindustries, such as consulting firms, can directly influence their major cost—salaries and wages—by adjusting the number of employees as demand changes.Thus, they’re much less subject to the effects of the operating leverage phenome-non In many businesses, the use of temporary or contract employees has risendramatically in recent years, reflecting the desire to reduce in part the more long-term obligations associated with regular employees.

As we mentioned before, in most situations management should assesswhether there would be value in reducing the level of fixed costs through creativesolutions such as outsourcing, partnering, and contract work arrangements thatmove the responsibility for fixed expense obligations elsewhere Such assess-ments became a growing phenomenon in the 90s during the widespread efforts atcorporate restructuring and reengineering Naturally, there are trade-offs involved

in such choices, such as giving up control over what might be important elements

All three are in one way or another related to volume We’ll demonstrate the

effect of changes in all three by varying the basic conditions in our example

Effect of Lower Fixed Costs

If management can lower fixed costs through energetic reductions in overhead by

using facilities more intensively, by contracting out part of its production, orthrough other restructuring of the company’s activities, the break-even pointmight be lowered significantly As a consequence, the boosting effect on profitswill start at a lower level of operations Figure 6–2 shows this change

Note that reducing fixed costs by one-eighth has led to a correspondingreduction in break-even volume It will now take one-eighth fewer units contrib-uting $500 each to recover the lower fixed costs From the table we can observethat successive 25 percent volume changes from the reduced break-even pointlead to increases or decreases in profit that are quite similar to our first example inFigure 6–1 Reducing fixed costs, therefore, is a very direct and effective way oflowering the break-even point to improve the firm’s profit performance

Effect of Lower Variable Costs

If management is able to reduce the variable costs of production (direct costs),thereby increasing the contribution per unit, the action can similarly affect profits

at current levels and influence the movement of the break-even point itself In ure 6–3, we’ve shown the resulting change in the slope of the variable cost line,which in effect widens the area of profits At the same time, loss conditions arereduced.

Fig-However, the change in break-even volume resulting from a 10 percentchange in variable costs is not as dramatic as the change experienced when fixedcosts were lowered by one-eighth The reason is that the reduction applies only to

a small portion of the total production cost, as variable costs are relatively low inthis example (This illustrates the point we made earlier about having to considerthe relative cost proportions in this type of analysis.)

F I G U R E 6–2

ABC CORPORATION Simple Operating Break-Even Chart: Effect of Reducing Fixed Costs

$750 250

$500

Break-even volume 350 units

Profits

Break-even point

Fixed costs of $175,000

Losses

100 200 300 400 500 600 700 800 900 1,000

Original condition

Profits and Losses as a Function of Volume Changes of 25 Percent

Only at the full capacity (1,000 units) does the profit impact of $25,000 respond to the effect of the reduction of $25,000 in fixed costs in the earlier ex-ample At lower levels of operations, lower unit volumes and the lesser impact ofvariable costs combine to minimize the effect Nevertheless, the result is a clearimprovement in the break-even condition, and a profit boost is achieved earlier onthe volume scale Again, 25 percent incremental changes are tabulated to show thespecific results.

cor-F I G U R E 6–3

ABC CORPORATION Simple Operating Break-Even Chart: Effect of Reducing Variable Costs

(reduction of $25 per unit)

Profits

Losses

Variable costs of $225/unit

$800 700 600 500 400 300 200 100 0

Contribution per unit Revenue

Variable costs Contribution

Fixed costs of $200,000

$750 225

$525

Break-even volume 381 units

Break-even point

100 200 300 400 500 600 700 800 900 1,000

Original condition

Profits and Losses as a Function of Volume Changes of 25 Percent

*First 25 percent change not exactly equal due to rounding.

†Infinite because the base is zero.

Effect of Lower Prices

Up to this point, we’ve concentrated on cost effects which are largely under

man-agement’s control In contrast, price changes are for the most part dependent onthe firm’s competitive environment As a result, price changes normally affect thecompetitive equilibrium and will directly influence the unit volume a business isable to sell Thus, it’s not enough to trace the effect of raised or lowered prices onthe break-even chart, but we also must anticipate the likely impact on volumeresulting from the price change In other words, raising the price could more thanproportionally affect the unit volume the company will be able to sell competi-tively, and the price action could actually result in lower total profits Conversely,lowering the price could more than compensate for the lost contribution perunit by significantly boosting the total unit volume that can be sold againstcompetition

Figure 6–4 demonstrates the effect of lowering the price by $50 per unit,

a 6.7 percent reduction Note that this change raises the required break-even volume by about 11 percent, to 444 units In other words, the company needs tosell an additional 44 units just to recoup the loss in contribution of $50 from thesale of every unit

For example, if the current volume was 800 units, with a contribution

of $400,000 and a profit of $200,000, the price drop of $50 per unit would require the sale of enough additional units to recover 800 times $50, or $40,000.The new units required will, of course, provide the lower per-unit contribution

of $45

have to be sold at the lower price to maintain the $200,000 profit level, which resents a volume increase of 11 percent Note that this results in a more than pro-portional change in unit volume (11 percent) versus the drop in price (6.7percent) Price changes affect internal operating results, but they could have aneven more pronounced and lasting impact on the competitive environment If amore than proportional volume advantage—and therefore improved profits—can

rep-be obtained over a significant period of time after the price has rep-been reduced, thiscould change the competitive situation to the company’s advantage Otherwise, ifprice reductions can be expected to be quickly matched by other competitors, thefinal effect could simply be a drop in profit for everyone, because little if any shift

in relative market shares would result The airline price wars mentioned earlier are

a prime example of this phenomenon

This isn’t the place to discuss the many strategic issues involved in pricingpolicy; the intent is merely to show the effect of this important factor on theoperating area of the business system and to provide a way of analyzing likelyconditions

Multiple Effects on Break-Even Conditions

Up to now, we’ve analyzed cost, volume, and price implications and their impact

on profit separately In practice, the many conditions and pressures encountered

by a business often affect these variables simultaneously Cost, volume, and price

for a single product might all be changing at the same time in subtle and oftennon-measurable ways The analysis is further complicated when several products

or services are involved, as is true of most major companies In such cases,changes in the sales mix can introduce many additional complexities

Moreover, our simplifying assumption to make production and sales taneous doesn’t necessarily hold true in practice; the normal lag between produc-tion and sales has a significant effect In a manufacturing company, sales and

simul-F I G U R E 6–4

ABC CORPORATION Simple Operating Break-Even Chart: Effect of Reducing Price

(reduction of $50 per unit)

Profits

Losses

$800 700 600 500 400 300 200 100 0

Contribution per unit Revenue

Variable costs Contribution

$700 250

$450

Break-even volume 444 units

Break-even point

100 200 300 400 500 600 700 800 900 1,000

Original condition Revenue – price of $700/unit

Fixed costs of $200,000

Profits and Losses as a Function of Volume Changes of 25 Percent

*First 25 percent change not exactly equal due to rounding.

†Infinite because the base is zero.

production can be widely out of phase Some of the implications of this conditionwere discussed in Chapter 3, when we dealt with funds flow patterns caused byvarying levels of operations, and in Chapter 5 when we examined the relationship

of cash budgets and pro forma income statements

So far we’ve also assumed that operating conditions were essentially linear.

This allowed us to simplify our analysis of leverage and break-even conditions

A more realistic framework is suggested in Figure 6–5 The chart shows potentialchanges in both fixed and variable costs over the full range of operations Possi-ble price–revenue developments are also indicated In other words, changes in allthree factors affecting operating leverage are reflected at the same time

Figure 6–5 further shows that the simple straight-line relationships used inFigures 6–1 through 6–4 are normally only approximations of the “step functions”and the gradual shifts in cost and price often encountered under realistic circum-stances Inflationary distortions arising over time also must be considered A fewexamples of the possible changes and likely reasons are described below

Target Profit Analysis

One application of operational leverage calculations is the use of target profitanalysis as part of the planning process of a company It takes into account the

F I G U R E 6–5

ABC CORPORATION Generalized Break-Even Chart:

Allowing for Changing Cost and Revenue Conditions

A A new layer of fixed costs is triggered by growing volume.

B A new shift is added, with additional requirements for overhead costs.

C A final small increment of overhead is incurred as some operations require overtime.

D Efficiencies in operations reduce variable unit costs.

E The new shift causes inefficiencies and lower output, with more spoilage.

relative proportions of fixed and variable costs expected to occur in the company’s

system Given projections of total fixed costs (F), estimates of variable costs (C), and expected price (P), the unit volume required to achieve any desired pretax tar- get profit (TP) can be determined with the basic break-even formula:

Volume for target profit: V

Similarly, if management wishes to test the level of variable costs (C) allowable for any desired pretax target profit (TP), with an estimated unit vol- ume (V) and price (P) based on expected market conditions and projected fixed costs (F), the formula can be rewritten as:

Variable unit cost for target profit: C  P 

The reader is invited to rewrite the formula for the required price to achieve

a desired pretax profit, and also to determine the change required to put the mula on an after-tax basis Calculations of this kind serve well to scope the di-mensions of the planning process, but cannot be substituted for detailed analysisand projections as discussed in Chapter 5 The approach is helpful for analysts andmanagers to recognize in broad terms the implications of the company’s operatingleverage

for-Financial Leverage

The concept of introducing an element of fixed cost into the financial system alsoapplies to financial leverage In the case of operating leverage, we saw that ad-vantage can be gained from a fixed level of cost that serves a wide variety of vol-ume conditions With financial leverage, advantage is gained from the expectationthat funds borrowed at a fixed interest rate can be used for investment opportuni-ties earning rates of return higher than the interest paid on the funds The differ-ence, of course, accrues as profit to the owners of the business and boosts thereturn on equity, as seen in Chapter 4 Viewed superficially, the implication would

be that as long as a company’s investments consistently provide returns above thisrate of interest, the augmented rate of return on equity would benefit the share-holders The opposite would, of course, apply if the company earned returns on itsinvestments below the rate of interest paid

We remember, however, that the basic principle of value creation requiresthat the return on all investments already in place as well as on any future invest-ments must exceed not only the interest paid on debt but also the expectations ofthe holders of the company’s shares Shareholder value can be created only if thecombined cost of capital, representing all long-term funding sources, is consis-tently exceeded We established this principle early on and will revisit it in detail

in Chapters 9 and 12 This return requirement doesn’t affect or alter the principles

of leverage itself, but it forces us to think carefully about the minimum level of turn with which resources have to be employed Instead of considering the rate of

re-(F  TP) V

F  TP

P  C

interest as the threshold return, it’s the overall cost of capital that must be met andexceeded.

Given that higher standard, however, the effect of financial leverage is stillderived from the fixed nature of the interest charges relative to the overall returncreated, with the difference, positive or negative, accruing to the shareholders.The principle is simple: Using return on shareholders’ equity as the criterion, thehigher the proportion of debt—and its fixed interest charges—in the capital struc-ture, the greater will be the leverage contribution to the return on shareholders’equity, for a given positive return achieved on the investments Conversely, asachieved returns drop below the rate of interest (tax-adjusted), the fixed nature ofthe interest charges will begin to magnify the reduction in return on equity Thereader will recall the diagram in Chapter 4, p 136, which shows the connection offinancial leverage to return on equity

To illustrate the relationships further, Figure 6–6 shows the leverage fect on the return on equity measure under three different levels of return on netassets All three curves are drawn with the assumption that funds can be borrowed

ef-at 4 percent per year after taxes If the normal return before interest, after taxes

on the company’s capitalization is 20 percent (curve A), growing proportions

of debt cause a dramatic rise in return on equity This return jumps to infinity asdebt nears 100 percent—obviously a dangerous extreme in capital structure

F I G U R E 6–6

ABC CORPORATION Return on Equity as Affected by Financial Leverage (after-tax interest on debt is 4 percent)

100

90 80 70 60 50 40 30 20 10

0

Debt as percentage of capitalization

Return on net assets = 20%

Return on net assets = 12%

Return on net assets = 5%

proportions Curves B and C show the leverage effect under more modest

invest-ment return conditions While somewhat lessened, the return on equity still showssharp increases as the proportion of debt rises We haven’t drawn the downwardsloping curves that would reflect a sharp plunge in negative return on equity whenthe return drops below 4 percent, the after-tax cost of interest This effect is also

suggested by the increase in the distances between curves A, B, and C at higher

debt levels

To express financial leverage relationships formally, we begin by defining

the components, as we did in the case of operating leverage Profit after taxes (I) now has to be related to shareholders’ equity (E) and long-term debt (D) We also single out the return on shareholders’ equity (R), and the return on capitalization (net assets) (r) before interest and after taxes, and the after-tax rate of interest (i).

First we define the return on shareholders’ equity as:

R and the return on capitalization (the sum of equity and debt) as:

r

We now restate profit (I) in terms of its components:

I  r (E  D)  Di

which represents the difference between the return on the total capitalization

(E  D) and the after-tax cost of interest on outstanding debt (Di) We substitute this restated profit for R in our initial return on equity formula, which now reads:

R  r

and which can be further rewritten as:

R  r  (r  i)

This formulation highlights the leverage effect, represented by the positive

expression after r (that is, the proportion of debt to equity), multiplied by the

dif-ference between the earnings power of net assets and the after-tax cost of interest.Thus, to the extent that debt is introduced into the capital structure, the return onequity is boosted as long as after-tax interest cost doesn’t exceed earnings power

This is the net leverage contribution, which we displayed in our systems view of

key ratios in Chapter 4 on p 136 Companies with different degrees of leveragewill, even if their earnings power is the same, achieve different returns on equitydue to the specific net leverage contribution (or detraction) caused by their capi-tal structures Analysts must therefore be careful in making direct comparisons ofROE results

D E

(E  D)  Di E

I  Di

E  D I E

206 Financial Analysis: Tools and Techniques

When we apply the formula to one set of conditions that pertained to

r 12 percent, if

In this illustration, we have four different debt/equity ratios, ranging from

no debt in the first case to a 3:1 debt/equity relationship in the fourth case Given

an after-tax cost of interest of 4 percent, and the normal opportunity to earn

12 percent after taxes on net assets invested, the return on equity in the first case

is also 12 percent after taxes—because no debt exists, and the total capitalization

is represented by equity

As increasing amounts of debt are introduced to the capital structure, ever, the return on equity is boosted considerably, because in each case, the return

how-on investment far exceeds the cost of interest paid to the debt holders This was,

of course, demonstrated in the graph of Figure 6–6 The reader is invited to workthrough the opposite effect, that is, interest charges in excess of the ability to earn

a return on the investments made with the funds

We’re also interested in the impact of leverage on the return on net assets,

or capitalization (r), which we obtain first by reworking the formula

R  r  (r  i)

into

r

return on capitalization necessary to obtain a return on equity of 12 percent, for

This is a useful way of testing the expected return from new investments.The approach simply turns the calculation around by fixing the return on equityand letting the expected return on investment vary The process is straightforward.Note that the required amount of earnings on net assets, or capitalization, dropssharply as leverage is introduced, until it begins to approach the 4 percent after-tax interest cost It’ll never quite reach this figure, however, because normally

RE  Di

E  D

D E

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