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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.