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Operating / Financial / Combined Leverage

The Alexander Company reported the following income statement for 2006:
Sales $15,000,000
Less Operating expenses
Wages, salaries, benefits $ 6,000,000
Raw materials 3,000,000
Depreciation 1,500,000
General, administrative, and selling expenses 1,500,000
Total operating expenses 12,000,000
Earnings before interest and taxes (EBIT) $ 3,000,000
Less Interest expense 750,000
Earnings before taxes $ 2,250,000
Less Income taxes 1,000,000
Earnings after taxes $ 1,250,000
Less Preferred dividends 250,000
Earnings available to common stockholders $ 1,000,000
Earnings per share-250,000 shares outstanding $ 4.00

Assume that all depreciation and 75 percent of the firms general, administrative, and selling expenses are fixed costs and that the remainder of the firm's operating expenses are variable costs.
a. Determine Alexander's fixed costs, variable costs, and variable cost ratio.

b. Based on its 2006 sales, calculate the following: The firms DOL The firms DFL The firms DCL

c. Assuming that next year's sales increase by 15 percent, fixed operating and financial costs remain constant, and the variable cost ratio and tax rate also remain constant, use the leverage figures just calculated to forecast next year's EPS.

d. Show the validity of this forecast by constructing Alexander's income statement for next year according to the revised format.

Solution Summary

The solution explains the calculation of DOL,DFL and DCL