Question

How can I determine current DOL (degree of operating leverage), DFL (degree of financial leverage), and DCL (degree of combined leverage)? If maximization of earning per share is the goal, what is the indifference EBIT (EBIT*)? Also, Once the expansion is completed, the sales are expected to increase to $5,000,000. How can I calculate the new EBIT. At the new EBIT which method of financing results in a higher EPS? Calculate EPS for both plans at this new EBIT.

new preferred shares with a dividend of 3%. Plan B will remain the same. What will be the new indifference EBIT (EBIT*)? (4 marks) Problem #4: (17 marks) Yellow Tartan is a levered firm with the following financial statements: Balance Sheet Income Statement Total assets $ 1,000,000 Sales Variable costs Fixed costs $ 3,500,000 $ 1,200,000 $ 1,000,000 Bonds (coupon rate of $ 200,000 8%) $ 300,000 Depreciation $ 600,000 Bonds (coupon rate of 6%) Common stock (50,000 $ 250,000 EBIT $ 700,000 o/s) ?? Retained earnings $ 250,000 Interest ?? ЕВТ Total liability $ 1,000,000 Taxes (40%) ?? NI ?? Yellow Tartan is planning to raise $400,000 through the sale of common stock at $50 per share or through the issuance of debt with a 10% annual coupon rate.

Answer 1

Solved below for the leverages and the EBIT Indifference, You can observe that at EBIT Indifference, both options have the same EPS of 3

Sales VC's Contribution FC's incl Depreciation EBIT Interest PBT Taxes NI 35,00,000 12,00,000 23,00,000 16,00,000 7,00,000 34,000 200000 X 8% + 300000 X 6% 6,66,000 2,66,400 3,99,600 DOL DFL DCL 3.29 C/EBIT 1.05 EBIT/PBT 3.45 OLX FL

Option1EPSEquity (X-34000) *0.6 50000+8000 Option 2EPS Debt (X-34000-40000) *0.6 50000 3,24,000 Check for Option 1 EPS Check for Option 2 EPS 3.00 3.00

The EBIT Indifference is $324,000.

Appended below is the new EPS if the Equity Option is followed

Option 1 -- Equity Sales 50,00,000 VC's 17,14,286 Contribution 32,85,714 FC's incl Depre 16,00,000 EBIT 16,85,714 Interest 34,000 PBT 16,51,714 Taxes 6,60,686 NI 9,91,029 NOS 58,000.00 EPS 17.09

Appended below is the new EPS if the Debt Option is followed (this gives a higher EPS as it's beyond Indifference Point)

Option 2 -- Debt Sales 50,00,000 VC's 17,14,286 Contributi 32,85,714 FC's incl D 16,00,000 EBIT 16,85,714 Interest 74,000 PBT 16,11,714 Taxes 6,44,686 NI 9,67,029 NOS 50,000.00 EPS 19.34