Question
DeSoto Tools Inc. is planning to expand production. The expansion will cost $4,400,000, which can be financed either by bonds at an interest rate of
DeSoto Tools Inc. is planning to expand production. The expansion will cost $4,400,000, which can be financed either by bonds at an interest rate of 6 percent or by selling 88,000 shares of common stock at $50 per share. The current income statement before expansion is as follows: |
DeSoto Tools Inc. Income Statement 201X | ||
Sales. | $ | 3,260,000 |
Variable costs | 1,304,000 | |
Fixed costs | 824,000 | |
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Earnings before interest and taxes | $ | 1,132,000 |
Interest expense | 640,000 | |
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Earnings before taxes | $ | 492,000 |
Taxes (@ 40%) | 196,800 | |
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Earnings after taxes | $ | 295,200 |
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Shares | 340,000 | |
Earnings per share | $ | .87 |
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After the expansion, sales are expected to increase by $1,740,000. Variable costs will remain at 40 percent of sales, and fixed costs will increase to $1,398,000. The tax rate is 40 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 I). These instructions apply throughout this problem.) (Round your answers to 2 decimal places.) |
Degree of operating leverage | |
Degree of financial leverage | |
Degree of combined leverage | |
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b. | Construct the income statement for the two alternative financing plans. (Input all amounts as positive values. Round EPS to 2 decimal places.) |
Debt | Equity | ||
(Click to select)InterestEarnings before interest and taxesSalesFixed costsVariable costs | $ | $ | |
(Click to select)SalesVariable costsEarnings before taxesTaxesInterest | |||
(Click to select)TaxesSalesEarnings after taxesEarnings before taxesFixed costs | |||
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(Click to select)Earnings after taxesEarnings before interest and taxesSalesEarnings before taxesFixed costs | $ | $ | |
(Click to select)Earnings after taxesEarnings before taxesSalesInterestTaxes | |||
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(Click to select)SalesEarnings before interest and taxesEarnings before taxesVariable costsEarnings after taxes | $ | $ | |
(Click to select)Earnings before interest and taxesFixed costsEarnings after taxesInterestTaxes | |||
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(Click to select)Earnings after taxesTaxesFixed costsInterestEarnings before taxes | $ | $ | |
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Common shares | |||
Earnings per share | $ | $ | |
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c. | Calculate the degree of operating leverage, the degree of financial leverage, and the degree of combined leverage, after expansion. (Round your answers to 2 decimal places.) |
Debt | Equity | |
Degree of operating leverage | ||
Degree of financial leverage | ||
Degree of combined leverage | ||
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