Question
DeSoto Tools Inc. is planning to expand production. The expansion will cost $3,700,000, which can be financed either by bonds at an interest rate of
DeSoto Tools Inc. is planning to expand production. The expansion will cost $3,700,000, which can be financed either by bonds at an interest rate of 6 percent or by selling 74,000 shares of common stock at $50 per share. The current income statement before expansion is as follows:
After the expansion, sales are expected to increase by $1,670,000. Variable costs will remain at 30 percent of sales, and fixed costs will increase to $1,384,000. The tax rate is 35 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.)
b. Construct the income statement for the two alternative financing plans. (Round EPS to 2 decimal places.)
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.)
DESOTO TOOLS INC. Income Statement 20x1 Sales Variable costs Fixed costs Earnings before interest and taxes Interest expense Earnings before taxes Taxes @ 35% Earnings after taxes Shares Earnings per share $3,170,000 951,000 817,000 $1,402,000 570,000 $ 832,000 291,200 $ 540,800 270,000 $ 2.00 Degree of operating leverage Degree of financial leverage Degree of combined leverage Debt Equity 0 0 0 0 0 0 Common shares Earnings per share Debt Equity Degree of operating leverage Degree of financial leverage Degree of combined leverage
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