Illinois Tool Company's (ITC) fixed operating costs are $1,260,000 and its variable cost ratio
(ie variable costs as a fraction of sales) is 0.70. The firm has $3,000,000 in bonds outstanding at an interest rate of 8%. ITC has 30,000 shares of $5 preferred stock and 150,000 of common stock outstanding. ITC is in the 50% corporate income tax bracket. Forecasted sales for next year are $9 million.
1. What is ITC's degree of operating leverage at a sales level of $9 million? Verbally explain what this means.
2. What is ITC's degree of financial leverage at an EBIT level of $1,440,000? Verbally explain what this means.
3. What is ITC's degree of combined leverage at a sales level of $10 million? Verbally explain what this means.
This solution calculates ITC's degree of operating leverage, degree of financial leverage and combined leverage at a specific sales level using the appropriate equations for operating leverage and financial leverage. It also discusses the outcome verbally and also includes all formulas and workings in an Excel file.