Question
DeSoto Tools Incorporated is planning to expand production. The expansion will cost $300,000, which can be financed either by bonds at an interest rate of
DeSoto Tools Incorporated 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:
DESOTO TOOLS INCORPORATED | |
---|---|
Income Statement 20X1 | |
Sales | $ 1,500,000 |
Variable costs | 450,000 |
Fixed costs | 550,000 |
Earnings before interest and taxes | $ 500,000 |
Interest expense | 100,000 |
Earnings before taxes | $ 400,000 |
Taxes @ 34% | 136,000 |
Earnings after taxes | $ 264,000 |
Shares | 100,000 |
Earnings per share | $ 2.64 |
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.
- 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=(STVC)(STVCFC)DOL=STVCSTVCFC . For the degree of combined leverage, use the formula: DCL=(STVC)(STVCFCI)DCL=STVCSTVCFCI . These instructions apply throughout this problem.)
Note: Round your answers to 2 decimal places.
- Construct the income statement for the two alternative financing plans.
Note: Round EPS to 2 decimal places. Enter your answers as positive values.
- Calculate the degree of operating leverage, the degree of financial leverage, and the degree of combined leverage, after expansion.
Note: Round your answers to 2 decimal places.
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