DeSoto Tools Inc. is planning to expand production. The expansion will cost $4,2
ID: 2816073 • Letter: D
Question
DeSoto Tools Inc. is planning to expand production. The expansion will cost $4,200,000, which can be financed either by bonds at an interest rate of 8 percent or by selling 84,000 shares of common stock at $50 per share. The current income statement before expansion is as follows DESOTO TOOLS INC. Income Statement 20X1 Sales Variable costs Fixed costs Earnings before interest and taxes Interest expense Earnings before taxes Taxes @ 30% Earnings after taxes Shares Earnings per share $3,240,000 648,000 822,000 $1,770,000 620,000 $1,150,000 345,000 $ 805,000 320,000 2.52 After the expansion, sales are expected to increase by $1,720,000. Variable costs will remain at 20 percent of sales, and fixed costs will increase to $1,394,000. The tax rate is 30 percent. a. Calculate the degree of operating leverage, the degree of financial leverage, and the degree of combined leverage before expansion. (For the degree of operating leverage, use the formula: DOL = (S-TVC) / (S-TVC-FC). For the degree of combined leverage, use the formula: DCL = (S-TVC) / (S-TVC-FC- These instructions apply throughout this problem.) (Round your answers to 2 decimal places.)Explanation / Answer
A-
Income statement
sales
3240000
less variable cost
648000
contribution
2592000
less fixed cost
822000
EBIT
1770000
less interest
620000
EBT
1150000
DOL = contribution/EBIT = 2592000/1770000
1.46
DFL = EBIT/EBT = 1770000/1150000
0.71
DCL = DOL * DDFL = .46*.71
2.25
B-
Debt
Equity
sales
4960000
4960000
less variable cost
992000
992000
contribution
3968000
3968000
less fixed cost
1394000
1394000
EBIT
2574000
2574000
less interest
336000
0
EBT
2238000
2574000
less tax-30%
671400
772200
net income
1566600
1801800
no of shares outstanding
320000
404000
EPS = net income/ no of shares outstanding
4.90
4.46
C-
DOL = contribution/EBIT = 3968000/2574000
1.54
3968000/2574000
1.54
DFL = EBIT/EBT = 2574000/2238000
1.15
2574000/2574000
1.00
DCL = DOL * DDFL = 1.54*1.15
1.77
1.54*1
1.54
A-
Income statement
sales
3240000
less variable cost
648000
contribution
2592000
less fixed cost
822000
EBIT
1770000
less interest
620000
EBT
1150000
DOL = contribution/EBIT = 2592000/1770000
1.46
DFL = EBIT/EBT = 1770000/1150000
0.71
DCL = DOL * DDFL = .46*.71
2.25
B-
Debt
Equity
sales
4960000
4960000
less variable cost
992000
992000
contribution
3968000
3968000
less fixed cost
1394000
1394000
EBIT
2574000
2574000
less interest
336000
0
EBT
2238000
2574000
less tax-30%
671400
772200
net income
1566600
1801800
no of shares outstanding
320000
404000
EPS = net income/ no of shares outstanding
4.90
4.46
C-
DOL = contribution/EBIT = 3968000/2574000
1.54
3968000/2574000
1.54
DFL = EBIT/EBT = 2574000/2238000
1.15
2574000/2574000
1.00
DCL = DOL * DDFL = 1.54*1.15
1.77
1.54*1
1.54
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