Question

6. The computation and interpretation of the degree of financial leverage (DFL) It is December 31. Last year, Galaxy Corporation had sales of $120,000,000, and it forecasts that next year’s sales will be $129,600,000. Its fixed costs have been—and are expected to continue to be—$66,000,000, and its variable cost ratio is 10.00%. Galaxy’s capital structure consists of a $15 million bank loan, on which it pays an interest rate of 12%, and 5,000,000 shares of outstanding common equity. The company’s profits are taxed at a marginal rate of 35%. Given this data, compute the following: Note: For these computations, round each EPS to two decimal places. • The company’s percentage change in EBIT is? . • The percentage change in Galaxy’s earnings per share (EPS) is ? . • The degree of financial leverage (DFL) at $129,600,000 is ? . The following are the two principal equations that can be used to calculate a firm’s DFL value

Answer 1

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Answer:

a) EBIT change

20.57%

b)

EPS change

21.49%

c)

DFL

= change in EPS/change in EBIT

= 21.49%/20.57%

= 1.0448

			% change
Sales	120000000	129600000
Less: Variable costs	12000000	12960000
Contribution	108000000	116640000
Less: Fixed costs	66000000	66000000
EBIT	42000000	50640000	20.57%
Less: Interest	1800000	1800000
EBT	40200000	48840000
lESS: taxes @35%	14070000	17094000
EAT	26130000	31746000
Shares	5000000	5000000
EPS	5.226	6.3492	21.49%