Chapter 13, Problem 1OR

a)

Summary Introduction

To discuss: The effect of decision on the Person L’s degree of total leverage.

Introduction:

Leverage refers to the borrowing of amount or debt to utilize for a purchase of equipment, inventory, and other assets of the company.

Explanation of Solution

Given information:

Person L has changes the financial strategy. The Person L’s annual revenues and its earnings per share (EPS) are as follows:

Year	Revenue	EPS
Feb,2011	$48,815	$1.52
Feb,2012	$50,208	$1.53
Feb,2013	$50,521	$1.80

The effect of decision on the Person L’s degree of total leverage is as follows:

The firm’s degree of leverage is influenced by financial and operating leverage. As per the Person L’s decisions, the operating leverage is unaffected by the decision in order to use the proceeds from issues of bonds to repurchase shares for the firm. However, this strategy of Person L would increase the firm’s financial leverage. At the time when the financial leverage increases then the firm’s 5total leverage also increases. The firm must reduce other fixed costs to reduce the total leverage.

b)

Summary Introduction

To determine: The percentage change in ESP and total revenue from 2011 to 2012 and even compute the degree of total leverage.

Introduction:

EPS are the portion of profit that distributed among the shareholders of the company. It can be obtained by dividing earnings available to equity shareholder and the number of outstanding share.

Explanation of Solution

Given information:

Person L has changes the financial strategy. The Person L’s annual revenues and its earnings per share (EPS) are as follows:

Year	Revenue	EPS
Feb,2011	$48,815	$1.52
Feb,2012	$50,208	$1.53
Feb,2013	$50,521	$1.80

The formula to compute the percentage change in total revenue is as follows:

$\text{Percentage change in total revenue}=\frac{\text{Current year revenue}-\text{Previous year revenue}}{\text{Previous year revenue}}\times 100$

The formula to compute the percentage change in EPS is as follows:

$\text{Percentage change in EPS}=\frac{\text{Current year EPS}-\text{Previous year EPS}}{\text{Previous year EPS}}\times 100$

The formula to compute the degree of total leverage is as follows:

$\text{Degree of total leverage}=\frac{\text{Percentage change in EPS}}{\text{Percentage change in total revenue}}$

Compute the percentage change in total revenue:

$\begin{array}{c}\text{Percentage change in total revenue}=\frac{\text{Current year revenue}-\text{Previous year revenue}}{\text{Previous year revenue}}\times 100\\ =\frac{\$50,208-\$48,815}{\$48,815}\times 100\\ =\frac{\$\text{1,393}}{\$48,815}\times 100\\ =2.85\%\end{array}$

Hence, the percentage change in total revenue is 2.85%.

Compute the percentage change in EPs:

$\begin{array}{c}\text{Percentage change in EPS}=\frac{\text{Current year EPS}-\text{Previous year EPS}}{\text{Previous year EPS}}\times 100\\ =\frac{\$1.53-\$1.52}{\$1.52}\times 100\\ =\frac{\$\text{0}\text{.01}}{\$1.52}\times 100\\ =0.66\%\end{array}$

Hence, the percentage change in EPS is 0.66%.

Compute the degree of total leverage:

$\begin{array}{c}\text{Degree of total leverage}=\frac{\text{Percentage change in EPS}}{\text{Percentage change in total revenue}}\\ =\frac{0.66\%}{2.85\%}\\ =0.23\end{array}$

Hence, the degree of total leverage is 0.23.

c)

Summary Introduction

To determine: The percentage change in revenues and EPS from 2012 to 2013 and even compute the degree of total leverage.

Explanation of Solution

Given information:

Person L has changes the financial strategy. The Person L’s annual revenues and its earnings per share (EPS) are as follows:

Year	Revenue	EPS
Feb,2011	$48,815	$1.52
Feb,2012	$50,208	$1.53
Feb,2013	$50,521	$1.80

The formula to compute the percentage change in total revenue is as follows:

$\text{Percentage change in total revenue}=\frac{\text{Current year revenue}-\text{Previous year revenue}}{\text{Previous year revenue}}\times 100$

The formula to compute the percentage change in EPS is as follows:

$\text{Percentage change in EPS}=\frac{\text{Current year EPS}-\text{Previous year EPS}}{\text{Previous year EPS}}\times 100$

The formula to compute the degree of total leverage is as follows:

$\text{Degree of total leverage}=\frac{\text{Percentage change in EPS}}{\text{Percentage change in total revenue}}$

Compute the percentage change in total revenue:

$\begin{array}{c}\text{Percentage change in total revenue}=\frac{\text{Current year revenue}-\text{Previous year revenue}}{\text{Previous year revenue}}\times 100\\ =\frac{\$50,521-\$50,208}{\$50,208}\times 100\\ =\frac{\$\text{393}}{\$50,208}\times 100\\ =0.62\%\end{array}$

Hence, the percentage change in total revenue is 0.62%.

Compute the percentage change in EPS:

$\begin{array}{c}\text{Percentage change in EPS}=\frac{\text{Current year EPS}-\text{Previous year EPS}}{\text{Previous year EPS}}\times 100\\ =\frac{\$1.80-\$1.53}{\$1.53}\times 100\\ =\frac{\$\text{0}\text{.27}}{\$1.53}\times 100\\ =17.65\%\end{array}$

Hence, the percentage change in EPS is 17.65%.

Compute the degree of total leverage:

$\begin{array}{c}\text{Degree of total leverage}=\frac{\text{Percentage change in EPS}}{\text{Percentage change in total revenue}}\\ =\frac{17.65\%}{0.62\%}\\ =28.46\end{array}$

Hence, the degree of total leverage is 28.46.

d)

Summary Introduction

To discuss: The interpretation aligns with the expectation of Person L.

Explanation of Solution

The interpretation aligns with the expectation of Person L is as follows:

As per the Person L’s expectations, the total leverage has raise tremendously from 0.23 to 28.46 times during the period. This has taken place after they changed their capital structure of the firm.

e)

Summary Introduction

To discuss: The beta of Person L’s common stock from the Year 2011 to 2013.

Explanation of Solution

The following would have happened to the beta of Person L’s common stock from the Year 2011 to 2013:

The Person L’s stock beta must have increased during the period. It is because the firm’s profits have been more sensitive towards the trends of the business than it was before the change in capital structure.