Assume that a firm has the following Income Statement Use this data to determine

Question

Assume that a firm has the following Income Statement Use this data to determine the business risk and the financial risk as measured by the degree of operating leverage and the degree of financial leverage, respectively. Also, determine the combined leverage as found with the degree of combined leverage. Utilize these risk measures to see the affect of a change in sales.

Income Statement
December 31, Year 1
Sales ($34/unit)
$34,000,000

Variable Cost ($20/unit)
$20,000,000
Fixed Cost
$10,000,000
EBIT
$4,000,000
Interest Expense
$120,000
EBT
$3,880,000
Taxes (40%)
$1,552,000

Net Income
$2,328,000


1.Calculate the DOL.
2.Calculate the DFL.
3.Determine the DCL
4. If sales increased by 20% determine the change in EBIT and the change in EPS (hint: Assume that the DOL, DFL and DCL remain constant).

Explanation / Answer

Sales $34,000,000 Variable Cost $20,000,000 Contribution $14,000,000 Fixed Cost $10,000,000 Net operating income (EBIT) $4,000,000 Interest $120,000 EBT $3,880,000 Tax $1,552,000 Net Income $2,328,000 1. Degree of Operating Leverage = Contribution / Net Operating Income = 14000000 / 4000000 = 3.5 2. Degree of Financial Leverage = Net Operating Income / Earning Before Tax = 4000000 / 3880000 = 1.03 3. Degree of Combined Leverage = Contribution / Earning Before Tax = 14000000 / 3880000 = 3.61 Degree of Combined Leverage = Contribution / Earning Before Tax = 14000000 / 3880000 = 3.61
100% 120% Sales $34,000,000 40800000 Variable Cost $20,000,000 24000000 Contribution $14,000,000 16800000 Fixed Cost $10,000,000 10000000 Net operating income (EBIT) $4,000,000 6800000 Interest $120,000 120000 EBT $3,880,000 6680000 Tax $1,552,000 2672000 Net Income $2,328,000 4008000 4. Changes in EBIT = 6800000 - 4000000 = $2,800,000 Changes in EBIT = 6800000 - 4000000 = $2,800,000 Changes in EPS EPS = Net Income / Number of shares outstanding In this problem there is no information about stock. Thank you..... Sales $34,000,000 Variable Cost $20,000,000 Contribution $14,000,000 Fixed Cost $10,000,000 Net operating income (EBIT) $4,000,000 Interest $120,000 EBT $3,880,000 Tax $1,552,000 Net Income $2,328,000

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