CHAPTER 12 Leverage and Capital Structure 549LG1 LG2
LG2LG3LG3ating cost of $0.84 and sells for $1.00. Fixed operating costs are $28,000. The
firm has annual interest charges of $6,000, preferred dividends of $2,000, and a
40% tax rate.
a. Calculate the operating breakeven point in units.
b. Use the degree of operating leverage (DOL) formula to calculate DOL.
c. Use the degree of financial leverage (DFL) formula to calculate DFL.
d. Use the degree of total leverage (DTL) formula to calculate DTL. Compare
this to the product of DOL and DFL calculated in parts band c.12 – 14 Integrative—Leverage and risk Firm R has sales of 100,000 units at $2.00 per
unit, variable operating costs of $1.70 per unit, and fixed operating costs of
$6,000. Interest is $10,000 per year. Firm W has sales of 100,000 units at $2.50
per unit, variable operating costs of $1.00 per unit, and fixed operating costs of
$62,500. Interest is $17,500 per year. Assume that both firms are in the 40%
tax bracket.
a. Compute the degree of operating, financial, and total leverage for firm R.
b. Compute the degree of operating, financial, and total leverage for firm W.
c. Compare the relative risks of the two firms.
d. Discuss the principles of leverage that your answers illustrate.12 – 15 Integrative—Multiple leverage measures and prediction Carolina Fastener,
Inc., makes a patented marine bulkhead latch that wholesales for $6.00.
Each latch has variable operating costs of $3.50. Fixed operating costs are
$50,000 per year. The firm pays $13,000 interest and preferred dividends of
$7,000 per year. At this point, the firm is selling 30,000 latches a year and is
taxed at 40%.
a. Calculate Carolina Fastener’s operating breakeven point.
b. On the basis of the firm’s current sales of 30,000 units per year and
its interest and preferred dividend costs, calculate its EBIT and net
profits.
c. Calculate the firm’s degree of operating leverage (DOL).
d. Calculate the firm’s degree of financial leverage (DFL).
e. Calculate the firm’s degree of total leverage (DTL).
f. Carolina Fastener has entered into a contract to produce and sell an addi-
tional 15,000 latches in the coming year. Use the DOL, DFL, and DTL to
predict and calculate the changes in EBIT and net profit. Check your work by
a simple calculation of Carolina Fastener’s EBIT and net profit, using the
basic information given.12 – 16 Various capital structures Charter Enterprises currently has $1 million in total
assets and is totally equity-financed. It is contemplating a change in capital struc-
ture. Compute the amount of debt and equity that would be outstanding if the
firm were to shift to each of the following debt ratios: 10, 20, 30, 40, 50, 60,
and 90%. (Note:The amount of total assets would not change.) Is there a limit
to the debt ratio’s value?12 – 17 Debt and financial risk Tower Interiors has made the forecast of sales shown in
the following table. Also given is the probability of each level of sales.