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Degree of combined leverage

Millennium Corp, Inc. has a base level of sales of 150,000 units. Sales price per unit is $10.00 and variable cost per unit is $6.50. Total annual operating fixed costs are $155,000, and the annual interest expense is $90,000. (For consistency with answers below, carry all calculations to two decimals.)

a) What is base level EBIT?

b) What is Millennium Corp.'s operating leverage? Provide an interpretation to describe Millennium's degree of operating leverage.

c) Assume that Millennium expects units sold to increase 20%. What will be the resulting percentage change in EBIT?

d) What will be the new level of EBIT given the expected 20% increase in units sold?

e) Calculate Millennium's degree of financial leverage. Provide an interpretation to describe Millennium's degree of financial leverage.

f) Calculate Millennium's degree of combined leverage. Provide an interpretation to describe Millennium's degree of combined leverage.

g) Assume that Millennium expects units sold to increase 20%. What will be the resulting percentage change in earnings per share?

h) Assume that Millennium's current level of earnings per share is $2.00. What will be the new level of earnings per share given the expected 20% increase in units sold?

Solution Preview

See the attached file.

Millennium Corp, Inc. has a base level of sales of 150,000 units. Sales price per unit is $10.00 and variable cost per unit is $6.50.
Total annual operating fixed costs are $155,000, and the annual interest expense is $90,000. (For consistency with answers below, carry all calculations to two decimals.)

a) What is base level EBIT?

EBIT is calculated in the following manner:

Per unit Value
Sales 10 1500000
Less Variable costs 6.5 975000
Contribution Margin 3.5 525000
Less Fixed costs 155000
EBIT= 370000

b) What is Millennium Corp.'s operating leverage? Provide an interpretation to describe Millennium's degree of operating leverage.

Operating leverage is calculated by Contribution/EBIT
=525000/370000
1.42 times
Interpretation: Higher operating leverage indicates greater operating risk. Millenium's Operating leverage is moderate which indicates ...

Solution Summary

Response provides steps to compute the degree of combined leverage.

$2.19