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Leverage and Capital Structure

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Johnson Manufacturing and Aaron Brothers Inc. are both involved in the production of brick for the homebuilding industry. Their financial information is as follows:

Johnson Aaron
Capital Structure
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
combined leverage?
b. If you combine Aaron's capital structure with Johnson's operating plan, what is the degree of
combined leverage?
c. In part b, if sales double, by what percent will EPS increase?


Solution Summary

The solution explains the impact of capital structure on operating leverage and combined leverage.