Bangle most recently sold 100,000 units at $7.50 each; its variable operating costs are $3.00 per...

Bangle most recently sold 100,000 units at $7.50 each; its variable operating costs are $3.00 per unit, and its fixed operating costs are $250,000. Annual interest charges total $80,000, and the firm has 8,000 shares of $5 (annual dividend) preferred stock outstanding. It currently has 20,000 shares of common stock outstanding. Assume that the firm is subject to a 40% tax rate.

Use the DTL concept to determine the effect (in percentage terms) of a 50% increase in Bangle’s sales from the $750,000 base level on its earnings per share.

Expert Solution

Effect on EPS = 421.875 % increase in EPS for a 50% increase in sales.

Explanation

Degree of Operating Leverage = Contribution / EBIT = 450,000 / 200000 = 2.25 Times

Degree of Financial leverage = EBIT / ( EBIT - Interest - Before tax Preferred dividend )

= 200,000 / ( 200000 - 80000 - 66,667 ) = 200,000 / 53,333 = 3.75 times

Note : - Before tax preferred dividend = Dividend / ( 1 - tax rate ) = 40000 / ( 1 - 0.40) = 66,667

DTL = Degree of total Leverage = DOL * DFL = 2.25 * 3.75 = 8.4375

If sales of the company increase by 50% ............. its EPS ( earnings per share) shall increase by 50 * 8.4375 = 421.875 %

Workings needed in above calculations

Income statement	Amount
Sales	750000
(-) Variable cost	300000
Contribution	450000
(-) Fixed cost	250000
EBIT	200000
(-) Interest	80000
EBT	120000
(-) Tax	48000
EAT	72000
(-) Prefered dividend	40000
Earnings available Equity	32000
EPS = 32000 / 20000	1.6

ekkarill92 answered 2 years ago

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