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A corporation reports sales of $3,000,000, variable costs of $1,000,000, fixed operating costs of $750,000, and...

A corporation reports sales of $3,000,000, variable costs of $1,000,000, fixed operating costs of $750,000, and interest expense of $250,000. The corporation's EBIT is $2,250,000 and its marginal tax rate is 30%. If the corporation is able to increase its sales by 25%, then

a. its EBIT will increase by 25% and its EPS will increase by 25%.

b. its EBIT will increase by more than 25% and its EPS will increase by less than 25%.

c. its EBIT and EPS will both increase, but less than 25% due to fixed costs and taxes.

d. its EBIT will increase by more than 25% and its EPS will increase by more than the percentage increase in EBIT.

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Answer #1
Sales 3000000
Variable cost 1000000
Contribution margin 2000000
Fixed operating cost 750000
EBIT 1250000
Interest expense 250000
EBT 1000000
Degree of operating leverage (DOL) = Contribution margin / EBIT = 2000000/1250000 1.6
Degree of Financial leverage (DFL) = EBIT / EBT = 1250000/1000000 1.25
Degree of operating leverage (DOL) = % change in EBIT / % change in sales
1.6 = % change in EBIT / 25%
% change in EBIT = 1.6*25% 40%
Degree of Financial leverage (DFL) = % change in EPS / % change in EBIT
1.25 = % change in EPS / 40%
% change in EPS = 40%*1.25 50%
Answer : Option d [ its EBIT will increase by more than 25% and its EPS will increase by more than the percentage increase in EBIT ]
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