Page 1 of S 0 - ZOOM + 1. The Alexander Company reported the following income statement for 2019: $14,000,000 Sales Less: Operating expenses Wages, salaries, benefits $5,000,000 Raw materials 4,000,000 Depreciation 1,500,000 Selling, general and administrative expenses 1.500.000 Total operating expenses Earnings before interest and taxes (EBIT) Less: Interest expenses Earnings before taxes Less: Income taxes Earnings after taxes Less: Preferred dividends Earnings available to common stockholders (EACS) Divided by: Number of common shares outstanding Earnings per share (EPS) $12.000.000 $ 2,000,000 750.000 1.250.000 375.000 875,000 250,000 625,000 250,000 S 2.50 I. DOL Assume that all depreciation and 65 percent of the firm's selling, general and administrative expenses are fixed costs, and that the remainder of the firm's operating expenses are variable costs. a. Determine Alexander's fixed costs, variable costs and variable cost ratio (for the variable cost ratio take your answer out to four decimal places). b. Based on its 2019 sales, calculate the following for the firm: ii. DFL iii. DCL c. Assume that 2020's sales decrease by 12 percent, that fixed operating and financial costs remain constant, and that the variable cost ratio and the average tax rate also remain constant. Use the leverage figures just calculated to forecast 2020 EPS. d. Show the validity of the forecast by constructing Alexander's income statement for 2020 according to the revised format (when constructing the income statement, there is no need to break down operating expenses into raw materials, depreciation or SGA expenses. Simply estimate variable and fixed operating expenses. Also, use the average tax rate in 2019 as the forecast year tax rate). e. Construct an EBIT-EPS graph based on Alexander's 2019 income statement. Be certain to show the EBIT (or x) axis intercept on your graph. Page ors 0 - ZOOM + 2. Gibson Company sales for the year 2019 were $4.5 million. The firm's variable operating cost ratio was 0.45 and fixed costs (that is, overhead and depreciation) were $1 million. Its average (and marginal) income tax rate is 25 percent. Currently, the firm has $2.4 million of long-term bank loans outstanding at an average interest rate of 12 percent. The remainder of the firm's capital structure consists of common stock (110,000 shares outstanding at the present time). a. Calculate Gibson's degree of combined leverage for 2019. b. Gibson is forecasting a 15 percent increase in sales for this year (2020). Furthermore, the firm is planning to purchase additional labor-saving equipment which will increase fixed costs by S200,000 and will reduce the variable cost ratio to 0.42. Financing this equipment with debt will require additional bank loans of S900,000. Calculate Gibson's expected degree of combined leverage for 2020 c. Determine how much Gibson must reduce its interest expenses in 2020 (for example, through the sale of common stock) to maintain its DCL at the 2019 level. d. Assuming that the debt is permanent (or perpetual) what is the reduction in debt associated with the interest expense reduction in partc? Page ors 0 - ZOOM + 2. Gibson Company sales for the year 2019 were $4.5 million. The firm's variable operating cost ratio was 0.45 and fixed costs (that is, overhead and depreciation) were $1 million. Its average (and marginal) income tax rate is 25 percent. Currently, the firm has $2.4 million of long-term bank loans outstanding at an average interest rate of 12 percent. The remainder of the firm's capital structure consists of common stock (110,000 shares outstanding at the present time). a. Calculate Gibson's degree of combined leverage for 2019. b. Gibson is forecasting a 15 percent increase in sales for this year (2020). Furthermore, the firm is planning to purchase additional labor-saving equipment which will increase fixed costs by S200,000 and will reduce the variable cost ratio to 0.42. Financing this equipment with debt will require additional bank loans of S900,000. Calculate Gibson's expected degree of combined leverage for 2020 c. Determine how much Gibson must reduce its interest expenses in 2020 (for example, through the sale of common stock) to maintain its DCL at the 2019 level. d. Assuming that the debt is permanent (or perpetual) what is the reduction in debt associated with the interest expense reduction in partc? Page
