Question

The Alexander Company reported the following income statement for 2016:

Sales $15,000,000

Less: Operating expenses

Wages, salaries, benefits $6,000,000

Raw materials 3,000,000

Depreciation 1,500,000

General, selling, and administrative expenses 1,500,000

Total operating expenses 12,000,000

Earnings before interest and taxes (EBIT) $3,000,000

Less: Interest expense 750,000

Earnings before taxes $2,250,000

Less: Income taxes 1,000,000

Earnings after taxes $1,250,000

Less: Preferred dividends 250,000

Earnings available to common stockholders $1,000,000

Earnings per share—250,000 shares outstanding $4.00

Assume that all depreciation and 75 percent of the firm’s selling, general, and administrative expenses are fixed costs and that the remainder of the firm’s operating expenses are variable costs.

a. Determine Alexander’s fixed costs, variable costs, and variable cost ratio.

b. Based on its 2016 sales, calculate the following for the firm:

•i. DOL

•ii. DFL

•iii. DCL

c. Assume that next year’s sales increase by 15 percent, that fixed operating and financial costs remain constant, and that the variable cost ratio and tax rate also remain constant. Use the leverage figures just calculated to forecast next year’s EPS.

d. Show the validity of this forecast by constructing Alexander’s income statement for next year according to the revised format.

e. Construct an EPS-EBIT graph based on Alexander’s 2016 income statement.

Answer 1