Question

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

	Sinclair			Boswell
Capital Structure
Debt @ 10%	$	1,920,000			0
Common stock, $10 per share		1,280,000		$	3,200,000
Total	$	3,200,000		$	3,200,000
Common shares		128,000			320,000
Operating Plan:
Sales (72,000 units at $15 each)	$	1,080,000		$	1,080,000
Variable costs		864,000			432,000
Fixed costs		0			322,000
Earnings before interest and taxes (EBIT)	$	216,000		$	326,000

The variable costs for Sinclair are $12 per unit compared to $6 per unit for Boswell.

a. If you combine Sinclair’s capital structure with Boswell’s operating plan, what is the degree of combined leverage? (Round your answer to 2 decimal places.)
Degree of combined leverage _____

b. If you combine Boswell’s capital structure with Sinclair’s operating plan, what is the degree of combined leverage? (Round your answer to the nearest whole number.)
Degree of combined leverage ____

c. In part b, if sales double, by what percentage will earnings per share (EPS) increase? (Round your answer to the nearest whole percent.)
EPS will increase by ____%

Answer 1

(a) Computation of the the degree of combined leverage.We have,

The degree of combined leverage(DCL):

The  Formula of DCL

DCL = Q(P - VC) / Q(P - VC) - FC - I

Where,

Q = Sales unit = 72,000 unit

P = Price per unit = $ 15.00

VC = Variable cost = $ 6.00

FC = Fixed Cost = $ 322,000

I = Interest expense = 1,920,000*10% = $ 192,000

By substituting these value in the above equation,we can get the value as below.

DCL = 72,000 ( 15 - 6) / [ 72,000(15-6) - 322,000 -192,000]

DCL = 648,000 / [ 648,000 - 322,000 - 192,000]

DCL = 648,000 / 134,000 =

DCL = 4.84

DCL

4.84

(b) Computation of the the degree of combined leverage.We have,

The degree of combined leverage(DCL):

The  Formula of DCL

DCL = Q(P - VC) / Q(P - VC) - FC - I

Where,

Q = Sales unit = 72,000 unit

P = Price per unit = $ 15.00

VC = Variable cost = $ 12.00

FC = Fixed Cost = 0

I = Interest expense = 0

By substituting these value in the above equation,we can get the value as below.

DCL = 72,000 ( 15 - 12) / [ 72,000(15-12) - 0 - 0]

DCL = 216,000 / [ 216,000 ]

DCL = 1.00

DCL

1.00

(c)

DCL =Percentage change in EPS / Percentage change in Sales

If sales double, then the percentage change in EPS is as follow:

1.00 = Percentage change in EPS / (144,000 - 72,000) / 72,000*100

1.00 = Percentage change in EPS / 100 %

Percentage change in EPS = 100 % X 1 = 100 %

Percentage change in EPS

100 %

Since,the percentage change in EPS is directly propertional to percentage change in sales if degree of combined leverage(DCL) is 1.00