The computation and interpretation of the degree of combined leverage (DCL)

You and your colleague, Madison, are currently participating in a finance internship program at Torres Industries. Your current assignment is to work together to review Torress 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 Madison decide to calculate Torress 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 Torress risk levels.

The most recent income statement for Torres Industries follows. Torres is funded solely with debt capital and common equity, and it has 3,000,000 shares of common stock currently outstanding.

	This Years Data	Next Years Projected Data
Sales	$40,000,000	$43,200,000
Less: Variable costs	20,000,000	21,600,000
Gross profit	20,000,000	21,600,000
Less: Fixed operating costs	8,000,000	8,000,000
Net operating income (EBIT)	12,000,000	13,600,000
Less: Interest expense	800,000	800,000
Taxable income (EBT)	11,200,000	12,800,000
Less: Tax expense (40%)	4,480,000	5,120,000
Net income	$6,720,000	7,680,000
Earnings per share (EPS)	$2.24	$2.56

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

Torres Industries Data
DOL (Sales = $40,000,000)
DFL (EBIT = $12,000,000)
DTL (Sales = $40,000,000)

Everything else remaining constant, assume Torres Industries decides to sell 520,000 shares of preferred stock that would pay $4 per share per year in cash dividends. How would this affect Torress DOL, DFL, and DCL?

	The DOL would be expected to .
	The DFL would be expected to .
	The DTL would be expected to .