Q5-8DQ Explain how combined leverage br... [FREE SOLUTION]

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Foundations Of Financial Management

Stanley B. Block, Geoffrey A. Hirt, Bartley Danielsen

Business Studies

16th Edition 路 768 pages

ISBN: 9781259277160

Chapter 2: Q5-8DQ (page 143)

Explain how combined leverage brings together operating income and earnings per share.

Short Answer

Expert verified

Operating leverage primarily affects the operating income of the company. And, the financial leverage determines the overall impact on earning per shares. Degree of combined leverage use the entire income statement and show the impact of change in sales on bottom line EPS. In other word, we can say that the degree of combined leverage is a combination of both degree of operating leverage and degree of financial leverage.

Step by step solution

Step-by-Step Solution:Step 1: Degree of combined leverage

Degree of combined leverage is computed to express the combined effect that the degree of operating leverage and the degree of financial leverage have on earning per share of the company.

Derivation of degree of combined leverage formula from DOL & DFL

$DCL = DOL 脳 DFL = \frac{Contribution}{EBIT} 脳 \frac{EBIT}{EBT} = \frac{Contribution}{EBT}$

As per the formula, it can be concluded that the combination of the degree of operating leverage and the degree of financial leverage is called as the degree of combined leverage, which will bring together the operating income and earning per share of the company together.

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Lancaster corporation
Sales	\(246,000
Cost of goods sold	122,000
Gross profit	\)124,000
Fixed charges (other than interest)	27,500
Income before interest and taxes	\(96,500
Interest	21,800
Income before taxes	\)74,700
Taxes (35%)	26,145
Income after taxes	$48,555

	20X1	20X2
Sales	\(3,230,000	\)3,370,000
Cost of goods sold	2,130,000	2,850,000
Gross profits	\(1,100,000	\)520,000
Selling and administrative expenses	298,000	227,000
Operating profits	\(802,000	\)293,000
Interest expense	47,200	51,600
Income before taxes	\(754,800	\)241,400
Taxes (35%)	264,180	84,490
Income after tax	\(490,620	\)156,910

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

Lenow		Hall
Debt @ 10%	\(100,000	Debt @ 10%	\)200,000
Common stock, \(10 par	200,000	Common stock, \)10 par	100,000
Total	\(300,000	Total	\)300,000
Shares	20,000	Common shares	10,000

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Explain how combined leverage brings together operating income and earnings per share.

Short Answer

Step by step solution

Step-by-Step Solution:Step 1: Degree of combined leverage

Derivation of degree of combined leverage formula from DOL & DFL

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