6. The computation and interpretation of the degree of financial leverage (DFL) It is December 31. Last year, Water and Power Company (W&P) had sales of $120,000,000, and it forecasts that next year's sales will be $129,600,000. Its fixed costs have been-and are expected to continue to be $66,000,000, and its variable cost ratio is 10.00%. W&P's capital structure consists of a $15 million bank loan, on which it pays an interest rate of 12%, and 5,000,000 shares of outstanding common equity. The company's profits are taxed at a marginal rate of 35%. Given this data, compute the following: Note: For these computations, round each EPS to two decimal places. The company's percentage change in EBIT is The percentage change in W&P's earnings per share (EPS) is The degree of financial leverage (DFL) at $129,600,000 is The following are the two principal equations that can be used to calculate a firm's DFL value: DFL (at EBIT = $X) Percentage Change in EPS Percentage Change in EBIT DFL (at EBIT = $X) = EBIT Preferred Diwdend's EBIT-Interest- (1 - Tax Rate) Consider the following statement about DFL, and indicate whether or not it is correct. The reason that the firm's preferred dividends are divided by (1 - Tax Rate) in the second equation is to adjust for the tax-deductibility of the dividends. This adjustment converts them from a pretax basis to an after-tax basis. False True 6. The computation and interpretation of the degree of financial leverage (DFL) It is December 31. Last year, Water and Power Company (W&P) had sales of $120,000,000, and it forecasts that next year's sales will be $129,600,000. Its fixed costs have been-and are expected to continue to be $66,000,000, and its variable cost ratio is 10.00%. W&P's capital structure consists of a $15 million bank loan, on which it pays an interest rate of 12%, and 5,000,000 shares of outstanding common equity. The company's profits are taxed at a marginal rate of 35%. Given this data, compute the following: Note: For these computations, round each EPS to two decimal places. The company's percentage change in EBIT is The percentage change in W&P's earnings per share (EPS) is The degree of financial leverage (DFL) at $129,600,000 is The following are the two principal equations that can be used to calculate a firm's DFL value: DFL (at EBIT = $X) Percentage Change in EPS Percentage Change in EBIT DFL (at EBIT = $X) = EBIT Preferred Diwdend's EBIT-Interest- (1 - Tax Rate) Consider the following statement about DFL, and indicate whether or not it is correct. The reason that the firm's preferred dividends are divided by (1 - Tax Rate) in the second equation is to adjust for the tax-deductibility of the dividends. This adjustment converts them from a pretax basis to an after-tax basis. False True
