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Finance Question - Degree of leverage

Van Auken Lumber:
Income Statement for December 31, 2007
($ thousand)

Sales $36,000
Cost of goods sold (25,200)
Gross Profit $10,800
Fixed operating costs (6,480)
Earnings before interest and taxes $4,320
Interest (2,880)
Earnings before taxes $1,440
Taxes (40%) (576)
Net Income $ 864

Dividends (50%) $432

Questions:

a) Compute the degree of operating leverage, degree of financial leverage, and degree of total leverage for Van Auken Lumber.

b) Interpret the meaning of each of the numerical values you computed in part (a)

c)Briefly discuss some ways that Van Auken can reduce its degree of total leverage

Solution Preview

Degree of operating leverage = Gross profit / EBIT = 10800 / 4320 = 2.50
Degree of financial leverage = EBIT / Net Income = 4320 / 864 = 5.0
Degree of total leverage = degree of operating leverage * degree of financial leverage = 2.50*5.0=12.50

b) Higher the value of degree of operating leverage (DOL), higher is the firm able to take advantage of its fixed costs. DOL of 2.5 indicates that an increase in 1.0 in gross profit for the firm leads to an ...

Solution Summary

The solution computes the degree of financial leverages, degree of financial leverage, and degree of total leverage for Van Auken Lumber.

$2.19