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    Calculationg degee of various Leverages

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    Problem 1

    You are supplied with the follwing analytical income statement for the your firm. It reflects last year's operations.

    Sales $16,000,000
    Variable Costs $8,000,000
    Revenue before fixed costs $8,000,000
    Fixed Costs $4,000,000
    EBIT $4,000,000
    Interest Expense $1,500,000
    Earning before taxes $2,500,000
    Taxes $1,250,000
    Net Income $1,250,000

    a) At what level of output, what is the degree of operating leverage?
    b) What is the degree of financial leverage?
    c) What is the degree of combined leverage?
    d) If the sales should increase by 20%, by what percent would Earnings before taxes (and net income) increase?
    e) What is your firm's break even point in sales dollars?

    Problem 2
    Discuss the risk return relationship involved in managing firm's working capital.

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    Solution Preview

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    Solution 1

    Sales = $16000000
    Variable Costs=$8000000
    Fixed Costs=$4000000
    EBIT = $ 4000000
    Net Income = $1250000

    a) Degree of Operating leverage is given by

    DOL of 2.0 means that for 100% change in Sales, EBIT will increase by 200%

    b) Degree of Financial leverage is given by

    EBIT=Sales-Fixed Costs-Variable ...

    Solution Summary

    In first problem Degree of operating, financial and combined leverages have been worked out with the help of suitable formulas.

    Second problem is small essay type. Risk return relationship involved in managing firm's working capital is explained.