Breakeven point and all forms of leverage TOR most recently sold 100,000 units a
ID: 2723268 • Letter: B
Question
Breakeven point and all forms of leverage TOR most recently sold 100,000 units at $7.50 each; its variable operating costs are $3.00 per unit, and its fixed operating costs are $250,000. Annual interest charges total $80,000, and the firm has 8,000 shares of $5 (annual dividend) preferred stock outstanding. It currently has 20,000 shares of common stock outstanding. Assume that the firm is subject to a 40% tax rate. a. At what level of sales (in units) would the firm break even on operations (that is, EBIT $0)? b. Calculate the firm’s earnings per share (EPS) in tabular form at (1) the current level of sales and (2) a 120,000-unit sales level. c. Using the current $750,000 level of sales as a base, calculate the firm’s degree of operating leverage (DOL). d. Using the EBIT associated with the $750,000 level of sales as a base, calculate the firm’s degree of financial leverage (DFL). e. Use the degree of total leverage (DTL) concept to determine the effect (in percentage terms) of a 50% increase in TOR’s sales from the $750,000 base level on its earnings per share.
Explanation / Answer
(a) If break-even quantity be Q, then
Revenue = Variable operating costs + Fixed operating costs (excluding interest charges)
$7.5 x Q = $3 x Q + $250,000
Q x $(7.5 - 3) = $250,000
Q x $4.5 = $250,000
Q = 55,555.56 units
(b)
(c) DOL = (Sales - Variable cost) / (Sales - Variable cost - Fixed costs excluding interest expense)
= $(750,000 - 300,000) / $(750,000 - 300,000 - 250,000) = $450,000 / $200,000 = 2.25
(d) DFL = EBIT / (EBIT - Interest expense)
= $200,000 / $(200,000 - 80,000) = $200,000 / $120,000 = 1.67
Note: First 4 sub-parts are answered.
Q = 100,000 Q = 120,000 Sales revenue: @$7.5 750000 900000 Less: Variable costs: @$3 300000 360000 Less: Fixed operating costs 2,50,000 2,50,000 EBIT 2,00,000 2,90,000 Less: Interest expense 80,000 80,000 Interest before tax 1,20,000 2,10,000 Less: Tax @40% 48,000 84,000 Net income (1) 72,000 1,26,000 Number of outstanding common shares (2) 20,000 20,000 EPS ($) (1) / (2) 3.6 6.3Related Questions
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