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# Operating, financial and total leverage

Use the following information to answer questions 1 and 2

Venture Inc. manufactures and sells headphones to airline and other passenger transportation companies. Each headphone sells for \$5.50, and this year sales are expected to be 1,750,000 units. Variable manufacturing costs for this level of manufacturing and sales (Venture does not have any inventories) are expected to total \$3,238,125. Fixed manufacturing costs will be \$4,550,000 for the coming period. It is expected that variable selling and administrative costs will be 2.0% percent of sales while fixed selling and administrative costs will total \$1,000,000. Venture currently has \$8,000,000 in debt outstanding with an annual cost of 4.5%. The company has 500,000 common shares outstanding, and no preferred shares. Venture's corporate tax rate
is 40%.

Venture is considering a reorganization that would see no increase in sales volume, however variable manufacturing costs would decrease by 20%, fixed manufacturing costs would increase by \$250,000; however variable selling costs would increase to 2.5% of sales while fixed would
decrease by \$100,000. This reorganization would cost the company \$3,000,000 which would be raised through the issue of additional debt at a cost of 3.5% (For purposes of this question, assume that these re-organization costs would be carried on the Balance Sheet).

1. What are the DOL and DFL (respectively) for Venture Inc. before the re-organization?
a. 3.48; 1.24
b. 3.77; 4.57
c. 9.61; 0.44
d. 9.61; 1.79
e. 9.61; 2.27

2. Assuming the re-organization occurs, and the DOL is correctly calculated at 6.21, which of the following is the DTL for Venture Inc.?
a. 3.5690
b. 6.8694
c. 10.8018
d. 11.3429
e. 14.6085

#### Solution Summary

The solution explains the calculation of DOL, DFL and DTL

\$2.19