Integrative: Leverage and risk Firm R has sales of 100,000 units at $2.00 per un

Question

Integrative: Leverage and risk Firm R has sales of 100,000 units at $2.00 per unit, variable operating costs of $1.70 per unit, and fixed operating costs of S6,000. Interest is $10,000 per year. Firm W has sales of 100,000 units at $2.50 per unit, variable operating costs of $1.00 per unit, and fixed operating costs of $62,500. Interest is $17,500 per year. Assume that both firms are in the 40% tax bracket. P13-16 2 bl of peatin,fimancial, and tnta lesenage for fim R. b. Compute the degree of operating, financial, and total leverage for firm W c. Compare the relative risks of the two firms. d. Discuss the principles of leverage that your answers illustrate.

Explanation / Answer

a & b Firm R Firm W Sales $200,000.00 $250,000.00 Less: Variable Cost $170,000.00 $100,000.00 Contribution Margin $30,000.00 $150,000.00 Less: Fixed Cost $6,000.00 $62,500.00 Operating Income = EBIT $24,000.00 $87,500.00 Less: Interest $10,000.00 $17,500.00 EBT $14,000.00 $70,000.00 DOL = Contribution Margin/ Operating Income 1.25 1.71 DFL = EBIT/EBT 1.71 1.25 DTL = DOL x DFL 2.14 2.14 c) Firm R has less operating risk but more financial risk than Firm W d) Two firms with differing operating and financial structure may be equally leveraged.Since total leverage is the product of operating and financial leverage, each firm may structure itself differently and still have the same amount of total leverage.

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