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Chapter 2: 10BP_b (page 147)

The Sterling Tire Company鈥檚 income statement for 20X1 is as follows:

STERLINE TIRE COMPANY

Income Statement

For the year ended December 31, 20X1

Sales (20,000 tires at \(60 each)

\)1,200,000

Less: variable costs (20,000 tires at \(30)

600,000

Less: fixed cost

400,000

Earnings before interest and taxes (EBIT)

\)200,000

Interest expenses

50,000

Earning before taxes (EBT)

\(150,000

Income tax expenses (30%)

45,000

Earning after taxe (EAT)

\)105,000

Given this income statement, compute the following:

b. Degree of financial leverage.

Short Answer

Expert verified

The degree of financial leverage is 1.33.

Step by step solution

01

Financial leverage

Financial leverage is computed to measure the company鈥檚 ability to meet its financial obligations.

02

Degree of financial leverage leverage

Degreeoffinancialleverage=EBITEBIT-Interest=$200,000$200,000-$50,000=1.33

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Most popular questions from this chapter

The balance sheet for Stud Clothiers is shown below. Sales for the year were \(2,400,000, with 90 percent of sales sold on credit.

Stud Clothier

Balance sheet 20X1

Assets

Liabilities and Equity

Cash

\)60,000

Account payable

\(220,000

Account receivable

240,000

Accrued taxes

30,000

Inventory

350,000

Bonds payable (long term)

150,000

Plant and equipment

410,000

Common stock

80,000

Paid in capital

200,000

Retained earnings

380,000

Total assets

\)1,060,000

Total LIbilities and Equity

$1,060,000

Compute the following:

e. Average collection period.

A firm has sales of \(3 million, and 10 percent of the sales are for cash. The year-end accounts receivable balance is \)285,000. What is the average collection period? (Use a 360-day year.)

In January 2007, the Status Quo Company was formed. Total assets were \(544,000, of which \)306,000 consisted of depreciable fixed assets. Status

Quo uses straight-line depreciation of \(30,600 per year, and in 2007 it estimated its fixed assets to have useful lives of 10 years. Aftertax income has been \)29,000 per year each of the last 10 years. Other assets have not changed since 2007.

b. To what do you attribute the phenomenon shown in part a?

For December 31, 20X1, the balance sheet of Baxter Corporation was as follows:

Current assets

Liabilities

Cash

\(15,000

Accounts payable

\)17,000

Accounts receivable

20,000

Notes payable

25,000

Inventory

30,000

Bonds payable

55,000

Prepaid expenses

12,500

Fixed assets

Stockholder鈥檚 equity

Plant and equipment (gross)

Less: accumulated depreciation

\(255,000

51,000

Preferred stock

\)25,000

Net plant and equipment

\(204,000

Common stock

60,000

Paid in capital

30,000

Retained earnings

69,500

Total assets

\)281,500

Total liabilities and stockholder鈥檚 equity

\(281,500

Sales for 20X2 were \)245,000, and the cost of goods sold was 60 percent of sales. Selling and administrative expense was \(24,500. Depreciation expense was 8 percent of plant and equipment (gross) at the beginning of the year. Interest expense for the notes payable was 10 percent, while the interest rate on the bonds payable was 12 percent. This interest expense is based on December 31, 20X1 balances. The tax rate averaged 20 percent.

\)2,500 in preferred stock dividends were paid, and \(5,500 in dividends were paid to common stockholders. There were 10,000 shares of common stock outstanding.

During 20X2, the cash balance and prepaid expenses balances were

unchanged. Accounts receivable and inventory increased by 10 percent. A new machine was purchased on December 31, 20X2, at a cost of \)40,000. Accounts payable increased by 20 percent. Notes payable increased by \(6,500 and bonds payable decreased by \)12,500, both at the end of the year. The preferred stock, common stock, and paid-in capital in excess of par accounts did not change.

c. Prepare a balance sheet as of December 31, 20X2.

Comment on why inflation may restrict the usefulness of the balance sheet as normally presented.
See all solutions

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