7. The computation and interpretation of the degree of combined leverage (DCL) You and your colleague, Emily, are currently participating in a finance internship program at Carter Chemical Company. Your current assignment is to work together to review Carters current and projected income statements. You will also assess the consequences of managements capital structure and investment decisions on the firms future riskiness. After much discussion, you and Emily decide to calculate Carters degree of operating leverage (DOL), degree of financial leverage (DFL), and degree of total leverage (DTL) based on this years data to gain insights into Carters risk levels.

The most recent income statement for Carter Chemical Company follows. Carter is funded solely with debt capital and common equity, and it has 2,000,000 shares of common stock currently outstanding.

This Years Data Next Years Projected Data

Sales $80,000,000 $86,000,000

Less: Variable costs 32,000,000 34,400,000

Gross profit $48,000,000 $51,600,000

Less: Fixed operating costs 28,000,000 28,000,000

Net operating income (EBIT) $20,000,000 $23,600,000

Less: Interest expense 4,000,000 4,000,000

Taxable income (EBT) $16,000,000 $19,600,000

Less: Tax expense (40%) 6,400,000 7,840,000

Net income $9,600,000 $11,760,000

Earnings per share (EPS) $4.80 $5.88

Given this information, complete the following table and then answer the questions that follow. When performing your calculations, round your EPS and percentage change values to two decimal places.

Carter Chemical Company

Data DOL (Sales = $80,000,000)

DFL (EBIT = $20,000,000)

DTL (Sales = $80,000,000)

Everything else remaining constant, assume Carter Chemical Company decides to sell 520,000 shares of preferred stock that would pay $4 per share per year in cash dividends.

How would this affect Carters DOL, DFL, and DCL?

The DOL would be expected to ____________________.

The DFL would be expected to ____________________.

The DTL would be expected to ____________________.