3. A review of the degree of financial leverage (DFL) It\'s December 31. Last ye

Question

3. A review of the degree of financial leverage (DFL) It's December 31. Last year, Campbell Construction had sales of $80,000,000, and it forecasts that next year's sales will be $76,000,000. Its fixed costs have been and are expected to continue to be $40,000,000, and its variable cost ratio is 11.00%. Campbell's capital structure consists of a $15 million bank loan, on which it pays an interest rate of 8%, and 750,000 shares of common equity. The company's profits are taxed at a marginal rate of 40%. Given this data, complete the following sentences: The percentage change in EBIT is The percentage change in earnings per share (EPS) is The degree of financial leverage (DFL) at $76,000,000 is The following are the two principal equations that can be used to calculate a firm's DFL value: Consider the following statement about DFL, and indicate whether or not it is correct. The reason that the firm's preferred dividends are divided by (1 - Tax Rate) in the second equation is to adjust for the tax-deductibility of the dividends. This adjustment converts them from a pretax basis to an after-tax basis. True False

Explanation / Answer

Ans

% change in EBIT = (EBIT of Forecasted year - EBIT of Current year)/EBIT of current year=

% Change in EPS = (EPS of current year -EPS of forecasted year)/EPS of current year.=

Degree of Financing Leverage=

11.4103%

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