A company is trying to decide on their use of operating and financial leverage f

Question

A company is trying to decide on their use of operating and financial leverage from among four choices. Their Interest Expense is the Interest Rate times Debt. Their Tax Rate is 40%

Please explain your answer

Option             Fixed Costs     Variable Costs             Debt    Interest Rate  

1.                    20000              70% of Sales               0                      0%      

2.                     50000              40% of Sales               0                      0%      

3.                     20000              70% of Sales               500,000           10%    

4.                     50000              40% of Sales               500,000           10%    

What is their Degree of Operating Leverage under option 1 if sales are $200,000?

What is their Degree of Financial Leverage under option 4 if EBIT is $120,000?

If Sales rise by 10% from 300,000 to 330,000 under option 3, then EBT will increase by what percent?

At what level of Sales will the Degree of Operating Leverage = 2 under Option 2?

At what level of Sales will the EBT under Option 1 equal the EBT under Option 4?

At what level of Net Income will options 2 and 3 have the same Net Income?

Explanation / Answer

QUESTION (3 )

IF SALES INCREASE TO $330000 THEN EBT INCREASED BY $ 9000 i.e. 9000 / 20000 = 45%

Q5) LET EBT = $X

EBT = S - VC = CONTRIBUTION - FC = EBIT - INTEREST = EBT

PARTICULARS $ OPTION 1 $ OPT 2 $ OPT 3 $ OPT 4 SALES 200000 300000 283333 LESS; VARIABLE COST 140000 210000 113333 CONTRIBUTION (A) 60000 90000 170000 LESS; FIXED COST 20000 20000 50000 EBIT (B) 40000 70000 120000 LESS ;INTEREST 0 50000 50000 EBT (c) 40000 20000 70000 DOL A / B 1.5 1.714 DFL B/ C 1

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