It is December 31. Last year, Water and Power Company (W&P) had sales of $80,000,000, and it forecasts that next year's sales will be $86,400,000. Its fixed costs have been-and are expected to continue to be-$44,000,000, and its variable cost ratio is 10.00%. W&P's capital structure consists of a $15 million bank loan, on which it pays an interest rate of 12%, and 5,000,000 shares of outstanding common equity. The company's profits are taxed at a marginal rate of 35%. The following are the two principal equations that can be used to calculate a firm's DFL value: DFL (at EBIT = $X) Percentage Change in EPS Percentage Change in EBIT Given this information, complete the following sentences: • The company's percentage change in EBIT is • The percentage change in W&P's earnings per share (EPS) is • The degree of financial leverage (DFL) at $86,400,000 is DFL (at EBIT = $X) O True O False Consider the following statement about DFL, and indicate whether or not it is correct. EBIT EBIT Interest Preferred Dividends (1-Tax Rate) (Hint: Use the changes in EPS and EBIT that you computed to determine DFL.) All other factors remaining constant, the larger the proportion of common equity used by the firm in its capital structure, the smaller the firm's DFL.
It is December 31. Last year, Water and Power Company (W&P) had sales of $80,000,000, and it forecasts that next year's sales will be $86,400,000. Its fixed costs have been-and are expected to continue to be-$44,000,000, and its variable cost ratio is 10.00%. W&P's capital structure consists of a $15 million bank loan, on which it pays an interest rate of 12%, and 5,000,000 shares of outstanding common equity. The company's profits are taxed at a marginal rate of 35%. The following are the two principal equations that can be used to calculate a firm's DFL value: DFL (at EBIT = $X) Percentage Change in EPS Percentage Change in EBIT Given this information, complete the following sentences: • The company's percentage change in EBIT is • The percentage change in W&P's earnings per share (EPS) is • The degree of financial leverage (DFL) at $86,400,000 is DFL (at EBIT = $X) O True O False Consider the following statement about DFL, and indicate whether or not it is correct. EBIT EBIT Interest Preferred Dividends (1-Tax Rate) (Hint: Use the changes in EPS and EBIT that you computed to determine DFL.) All other factors remaining constant, the larger the proportion of common equity used by the firm in its capital structure, the smaller the firm's DFL.
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Transcribed Image Text:7. A review of the degree of financial leverage (DFL)
It is December 31. Last year, Water and Power Company (W&P) had sales of $80,000,000, and it forecasts that next year's sales will be $86,400,000.
Its fixed costs have been-and are expected to continue to be-$44,000,000, and its variable cost ratio is 10.00%. W&P's capital structure consists of
a $15 million bank loan, on which it pays an interest rate of 12%, and 5,000,000 shares of outstanding common equity. The company's profits are
taxed at a marginal rate of 35%.
The following are the two principal equations that can be used to calculate a firm's DFL value:
DFL (at EBIT = $X)
Percentage Change in EPS
Percentage Change in EBIT
Given this information, complete the following sentences:
DFL (at EBIT $X)
Consider the following statement about DFL, and indicate whether or not it is correct.
O True
O False
EBIT
EBIT-Interest-
• The company's percentage change in EBIT is
• The percentage change in W&P's earnings per share (EPS) is
• The degree of financial leverage (DFL) at $86,400,000 is . (Hint: Use the changes in EPS and EBIT that you computed to determine DFL.)
Preferred Dividends
(1-Tax Rate)
All other factors remaining constant, the larger the proportion of common equity used by the firm in its capital structure, the smaller the
firm's DFL.
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Step 1: Formulae
VIEWStep 2: Computation of Original and Revised EBIT and EPS.
VIEWStep 3: Computation of Percentage change in EBIT.
VIEWStep 4: Computation of Percentage change in EPS.
VIEWStep 5: Computation of Degree of Financial leverage (DFL).
VIEWStep 6: Determining the statement true or false
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