Question

3. A firm’s product price is $50, and the firm sold 12,500 units. The variable cost is $29.60 per unit, and fixed operating costs are $200,000. Earnings before Interest and Taxes are $55,000. Earnings per Share are $1.38. Fixed interest expense is $10,000 per year, and the tax rate is 21%.

a. Compute the Degree of Operating Leverage. (5 points)

b. Compute the Degree of Financial Leverage. (5 points)

c. Compute the Degree of Total Leverage. (5 points)

d. A 6% increase in sales revenues is forecasted. Estimate the percentage change and dollar value of Earnings before interest and taxes. (5 points)

e. A 6% increase in sales revenues is forecasted. Estimate the percentage change and dollar value of Earnings per Share for next year. (5 points)

Answer #1

Selling price= $50

Units sold= 12500

Variable cost= $29.6

Fixed cost= $200000

EPS= $1.38

a: Sales= 50*12500 = 625000

Less: Variable costs = 29.6*12500 = 370000

Contribution = $255000

Less: Fixed cost= 200000

EBIT = $55000

Operating leverage= contribution / EBIT

= 255000/ 55000

=4.64 times

b: Financial leverage = EBIT/ (EBIT- Interest-Preferred Div/(1-T))

= 55000/ (55000-10000)

=1.22

c: Total leverage= Operating leverage x financial leverage

= 4.64*1.22

= 5.67

d : EBIT change= $15300 = 27.82%

e: EPS change= $0.47 = 34%

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