(See attached file for full problem description and complete chart).
Johnson Manufacturing and Aaron Brothers Inc. are both involved in the production of brick for the homebuilding industry. Their financial information is as follows:
Debt @ 12% $ 600,000 -
Common stock, $10 per share 400,000 1,000,000
Total 1,000,000 1,000,000
Common shares 40,000 100,000
Operating Plan 1,000,000 1,000,000
Sales (50,000 units at $20 each) 800,000 500,000
Less: Variable costs ($16 per unit) ($10 per unit)
Fixed costs 300,000
Earnings before interest and taxes (EBIT) $ 200,000 200,000
a. If you combine Johnson's capital structure with Aaron's operating plan, what is the degree of
b. If you combine Aaron's capital structure with Johnson's operating plan, what is the degree of
c. In part b, if sales double, by what percent will EPS increase?
The solution explains the impact of capital structure on operating leverage and combined leverage.