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Business Finance CONTEMP. FINANCIAL MGT.-W/MINDTAP V3

a) To determine: Degree of operating leverage at a sales level of $80 million. Given information: Operating cost= $10 million Variable cost ratio = 0.65 Company M has $20 million, 10% bank loan and $6 million, 12% bond issue outstanding. It has 1 million shares of preferred stock with dividend $5 and $1 par 2 million shares of common stock. Marginal rate = 40%. Expected sales = $80 million. Calculating the Variable cost: Variable cost = 0.65 × $ 80 , 000 , 000 = $ 52 , 000 , 000 Calculating the EBIT: EBIT = Sales - (Fixed cost + Variable cost) EBIT = $80,000,000 - ($10,000,000 + $ 52 , 000 , 000 ) =$18,000,000 Now, Calculating the Degree of operating leverage Degree of operating leverage = Sales - Variable cost EBIT = $80,000,000 - $52,000,000 $18,000,000 = 1.56 b) To determine: The degree of financial leverage at a sales level of $80 million. Calculating the financial leverage: Degree of financial leverage = EBIT ÷ EBIT − Interest − Preferred Dividend 1 − Tax rate = $18,000,000 ÷ $18,000,000 − $2,272,000 − $5,000,000 1 − 40% = 2.59 c) To determine: Forecasting the earning per share taking a sales decline of $76 million into consideration. Calculating the combined leverage: Degree of combined leverage = Degree of financial leverage × Degree of operating leverage =2 .59 × 1 .56 =4 .04 $76 million sales decline signifies 5% sales decline. Similarly, the earning per share is expected to decline by 20.2% (4.04*5%) Calculating the EPS: EPS= Sales - Variable operating cost - Fixed operating cost - Interest - Taxes - Preferred dividends Number of common shares = $ 80 , 000 , 000 - $ 52 , 000 , 000 - $ 10 , 000 , 000 - $2,720,000 - 1 − 40 % - $5,000,000 $2,000,000 = 2.08 Calculating forecasted EPS when sales reduce by $76 million: Forecasted EPS = Current EPS × 1 + Decline in the expected earning per share Forecasted EPS = 2 .08 × 1 + - 20 .2 = $ 1.66

a) To determine: Degree of operating leverage at a sales level of $80 million. Given information: Operating cost= $10 million Variable cost ratio = 0.65 Company M has $20 million, 10% bank loan and $6 million, 12% bond issue outstanding. It has 1 million shares of preferred stock with dividend $5 and $1 par 2 million shares of common stock. Marginal rate = 40%. Expected sales = $80 million. Calculating the Variable cost: Variable cost = 0.65 × $ 80 , 000 , 000 = $ 52 , 000 , 000 Calculating the EBIT: EBIT = Sales - (Fixed cost + Variable cost) EBIT = $80,000,000 - ($10,000,000 + $ 52 , 000 , 000 ) =$18,000,000 Now, Calculating the Degree of operating leverage Degree of operating leverage = Sales - Variable cost EBIT = $80,000,000 - $52,000,000 $18,000,000 = 1.56 b) To determine: The degree of financial leverage at a sales level of $80 million. Calculating the financial leverage: Degree of financial leverage = EBIT ÷ EBIT − Interest − Preferred Dividend 1 − Tax rate = $18,000,000 ÷ $18,000,000 − $2,272,000 − $5,000,000 1 − 40% = 2.59 c) To determine: Forecasting the earning per share taking a sales decline of $76 million into consideration. Calculating the combined leverage: Degree of combined leverage = Degree of financial leverage × Degree of operating leverage =2 .59 × 1 .56 =4 .04 $76 million sales decline signifies 5% sales decline. Similarly, the earning per share is expected to decline by 20.2% (4.04*5%) Calculating the EPS: EPS= Sales - Variable operating cost - Fixed operating cost - Interest - Taxes - Preferred dividends Number of common shares = $ 80 , 000 , 000 - $ 52 , 000 , 000 - $ 10 , 000 , 000 - $2,720,000 - 1 − 40 % - $5,000,000 $2,000,000 = 2.08 Calculating forecasted EPS when sales reduce by $76 million: Forecasted EPS = Current EPS × 1 + Decline in the expected earning per share Forecasted EPS = 2 .08 × 1 + - 20 .2 = $ 1.66

Solution Summary: The author calculates the degree of financial leverage at a sales level of 80 million.

CONTEMP. FINANCIAL MGT.-W/MINDTAP V3

CONTEMP. FINANCIAL MGT.-W/MINDTAP V3

14th Edition

ISBN: 9780357292839

Author: MOYER

Publisher: CENGAGE L

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CONTEMP. FINANCIAL MGT.-W/MINDTAP V3

Ch. 14.A - Prob. 1QTD Ch. 14.A - Prob. 2QTD Ch. 14.A - Prob. 3QTD Ch. 14.A - Prob. 2P Ch. 14.A - Prob. 3P Ch. 14.A - Prob. 4P Ch. 14.A - Prob. 5P Ch. 14.A - Prob. 6P Ch. 14.A - Prob. 7P Ch. 14.A - Prob. 8P

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