Barbara Beef and Freddy Fish will be opening a new fast food restaurant in out t

Question

Barbara Beef and Freddy Fish will be opening a new fast food restaurant in out two months. They estimate that first year sales will be $625,000 Food and labor (the variable costs) are expected to be 40% of sales while fixed costs will be $250,000. The total start-up costs (initial investment) will be $1,000,000. Two financing plans are being considered. Plan A calls for 50 percent debt and 50 percent equity financing with an interest rate of 10 percent on the borrowed funds. Plan B will be 100 percent equity financing Compute the DFL under each of the two proposed financing plans. (use the estimated sales figure as a base)

Explanation / Answer

Plan A Degree of financial Leverage = EBIT/(EBIT - Interest) = (625000-40%*625000-250000)/(625000-40%*625000-250000 - 1000000*10%) = 5 Plan B DFL = EBIT/(EBIT - Interest) = (625000-40%*625000-250000)/(625000-40%*625000-250000 - 0) = 1

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