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21. DeSoto Tools Inc. is planning to expand production. The expansion will cost $300,000, which can be financed either by bonds at an interest rate

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21. DeSoto Tools Inc. is planning to expand production. The expansion will cost $300,000, which can be financed either by bonds at an interest rate of 14 percent or by selling 10,000 shares of common stock at $30 per share. The current income statement before expansion is as follows: page 2 DesOTO TOOLS, INC Income Statement 20X1 p. 151 $1,500,000 $450,000 550.000 Sales Less: Variable costs Foced costs Earnings before interest and taxes Less: Interest expense Earnings before taxes Less: Taxes @34% Earnings after taxes Shares Earnings per share 1,000,000 $ 500.000 100.000 $ 400.000 136,000 $ 284.000 100.000 $ 2.84 After the expansion, sales are expected to increase by $1,000,000. Variable costs will remain at 30 percent of sales, and fixed costs will increase to $800,000. The tax rate is 34 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 leterage, use the formula developed in footnote 2; for the degree of combined leverage, use the formula developed in footote 3. These instructions apply throughout this problem.) 3. Construct the income statement for the two alternative financing plans c. Calculate the degree of operating leverage, the degree of financial leverage, and the degree of combined leverage, after expansion d. Explain which financing plan you favor and the risks involved with each plan

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