Problem 3 Below is Income Statement information for Raymond’s Rain suits. Revenu
ID: 2732087 • Letter: P
Question
Problem 3
Below is Income Statement information for Raymond’s Rain suits.
Revenue: $3,107,262
Variable costs: 30% of revenue
Fixed costs: $1,000,000
Depreciation: $475,000
Bond Issue A: $300,000 face value, 10% coupon
Bond Issue B: $500,000 face value, 8% coupon
Bond Issue C: $900,000 face value, 12% coupon
Tax rate: 40%
Common shares issued and Outstanding: 250,000
a. Calculate the degree of operating leverage for the firm. (2 marks)
b. Calculate the degree of financial leverage for the firm. (2 marks)
c. Calculate the degree of combined leverage for the firm. (2 marks)
d. If the company is able to increase their sales by 15%, what percentage increase in EPS would you expect to observe? (2 marks)
e. If the sales increase by 15%, what will the new EPS be? (2 marks)
Explanation / Answer
1)Degree of Operating Leverage=contribution÷operating income
=(sales-variable cost)÷(sales-variable cost-fixed cost)
=(3107262-932178.6)/(3107262-932178.6-1000000)
=1.85
2)Degree of financial leverage=EBIT÷(EBIT-Interet)
EBIT=Sales-variable cost-fixed cost-depreciation=3107262-932178.6-1000000-475000=700083.4
Interest=(300000×.10)+(500000×.08)+(900000×.12)=178000
DFL=700083.4÷(700083.4-178000)
=1.34 times
3)Degree of combined leverage=degree of operating leverage × degree of financoal leverage
=1.85×1.34
=2.48
4 and 5)old eps=(EBIT-interest-tax)÷no. Of shares
=(700083.4-178000-208833.36)÷250000
=1.25 times
New eps if sales increase by 15%
Sales=3107262×1.15=3573351.3
Variable cost=3573351.3×.30
Fixed cost=1000000
Depreciation=475000
Interest=178000
EBT=3573351.3-1072005.39-1000000-475000-178000=848345.91
TAX=40%× EBT=339338.364
EARNINGS AFTER TAX=509007.546
REVISED EPS=509007.546/250000
=2.036
%change in eps=(2.036-1.25)÷1.25=.6288
=62.88%
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