Calculate the degree of operating leverage, the degree of financial leverage, and the degree of combined leverage before expansion. (For the degree of operating leverage, use the formula: DOL = (S − TVC) / (S − TVC − FC). For the degree of combined leverage, use the formula: DCL = (S − TVC) / (S − TVC − FC − I). These instructions apply throughout this problem.) Note: Round your answers to 2 decimal places. Construct the income statement for the two alternative financing plans. Note: Round EPS to 2 decimal places. Enter your answers as positive values.
Financial Ratios
A Ratio refers to a figure calculated as a reference to the relationship of two or more numbers and can be expressed as a fraction, proportion, percentage, or the number of times. When the number is determined by taking two accounting numbers derived from the financial statements, it is termed as the accounting ratio.
Return on Equity
The Return on Equity (RoE) is a measure of the profitability of a business concerning the funds by its stockholders/shareholders. ROE is a metric used generally to determine how well the company utilizes its funds provided by the equity shareholders.
DeSoto Tools Incorporated is planning to expand production. The expansion will cost $2,200,000, which can be financed either by bonds at an interest rate of 9 percent or by selling 44,000 shares of common stock at $50 per share. The current income statement before expansion is as follows:
| DESOTO TOOLS INCORPORATED Income Statement 20X1 |
|
| Sales | $ 3,020,000 |
|---|---|
| Variable costs | 906,000 |
| Fixed costs | 802,000 |
| Earnings before interest and taxes | $ 1,312,000 |
| Interest expense | 420,000 |
| Earnings before taxes | $ 892,000 |
| Taxes @ 35% | 312,200 |
| Earnings after taxes | $ 579,800 |
| Shares | 120,000 |
| Earnings per share | $ 4.83 |
After the expansion, sales are expected to increase by $1,520,000. Variable costs will remain at 30 percent of sales, and fixed costs will increase to $1,354,000. The tax rate is 35 percent.
- Calculate the degree of operating leverage, the degree of financial leverage, and the degree of combined leverage before expansion. (For the degree of operating leverage, use the formula: DOL = (S − TVC) / (S − TVC − FC). For the degree of combined leverage, use the formula: DCL = (S − TVC) / (S − TVC − FC − I). These instructions apply throughout this problem.)
Note: Round your answers to 2 decimal places.
- Construct the income statement for the two alternative financing plans.
Note: Round EPS to 2 decimal places. Enter your answers as positive values.
Trending now
This is a popular solution!
Step by step
Solved in 5 steps with 2 images
