9. Given the following financial data for Boston Technology, Assume a marginal t
ID: 2802386 • Letter: 9
Question
9. Given the following financial data for Boston Technology, Assume a marginal tax rate of 40%.
a. Compute and discuss the degree of operating and financial leverage.
b. Compute and discuss the firm’s degree of combined leverage.
b. What happens to EPS if sales increase by 15%? 8% decrease? Compare and discuss the two.
2010
2011
Sales
$700,000
$760,000
Fixed costs
175,000
190,000
Variable costs
406,000
448,000
EBIT
119,000
122,000
Interest
42,000
46,000
Shares outstanding
100,000
102,000
2010
2011
Sales
$700,000
$760,000
Fixed costs
175,000
190,000
Variable costs
406,000
448,000
EBIT
119,000
122,000
Interest
42,000
46,000
Shares outstanding
100,000
102,000
Explanation / Answer
Degree of operating leverage (DOL) = %Change in EBIT / %Change in Sales
Degree of financial leverage (DFL) = %Change in EPS / %Change in EBIT
Degree of combined leverage (DCL) = %Change in EPS / %Change in Sales = DOL x DFL
% Change in Sales = (760 - 700) / 700 = 8.57%
% Change in EBIT = (122 - 119) / 119 = 2.52%
EPS = Net Income / No. of shares = (EBIT - Interest) x (1 - tax rate) / No. of shares
In 2010, EPS = (119,000 - 42,000) x (1 - 40%) / 100,000 = 0.462
In 2011, EPS = (122,000 - 46,000) x (1 - 40%) / 102,000 = 0.447
% Change in EPS = (0.447 - 0.462) / 0.462 = -3.23%
=> DOL = 2.52% / 8.57% = 29.41%, DFL = -3.23% / 2.52% = -128.28%
=> DCL = DOL x DFL = 29.41% x -128.28% = -37.73%
If sales increase by 15%, then change in EPS = -37.73% x 15% = -5.66%, i.e. EPS will decrease by 5.66%
If sales decrease by 8%, then change in EPS = -37.73% x -8% = 3.02%, i.e. EPS will increase by 3.02%
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