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Purchase Decision / Degree of Financial Leverage

5. You are considering the purchase of new equipment for your company and you have narrowed down the possibilities to two models which perform equally well. However, the method of paying for the two models is different. Model A requires $5,000 per year payment for the next five years. Model B requires the following payment schedule. Which model should you buy if your opportunity cost is 8 percent?
Year Payment (Model B)
1 $7,000
2 6,000
3 5,000
4 4,000
5 3,000

Table 8.1
Plan 1 Plan 2
Interest Expense $25,000 $50,000
Preferred Dividend $3,000 $1,500
Common Shares Outstanding 200,000 100,000

What is the degree of financial leverage at a base level EBIT of $120,000 for both financing plans? The firm has a 40 percent tax rate. (See Table 8.1.)

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Solution Summary

The solution looks at two questions - making the purchase decison among alternatives and how to calculate the degree of financial leverage. This solution is formatted in an attached Word document.