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The following is a list of selected information for Liverpool Co. for the fiscal year. Forecasted...

The following is a list of selected information for Liverpool Co. for the fiscal year.

	Forecasted Operations	Sales with 30.00% Increase	Unit Change
Sales in units (millions)	200	260	60
Earnings before interest and taxes (EBIT)	4,000.00	5,600.00	1,600.00
Less: Interest	(150.00)	(150.00)	(0.00)
Earnings before taxes	$3,850.00	$5,450.00	$1,600.00
Less: Taxes (40%)	1,540.00	2,180.00	(0.00)
Net income	2,310.00	3,270.00	960.00
Earnings per share (20 million shares)	$115.50	$163.50	$48.00

You are an employee for Liverpool Co., and your boss needs help assessing the level of risk associated with the firm’s current financial position. Begin by calculating the degree of financial leverage for the change between forecasted operations and the operational increase of 30.00%.

0.60X

1.04X

0.42X

1.03X

Your boss says, “Looking good so far. However, I would like to know how we stack up against our strongest competitor, Everton Co.” Compare the degree of operating leverage of Everton Co. with that of Liverpool Co. and then answer the following question.

All else being equal, is Liverpool Co. more risky than, less risky than, or as equally risky as Everton Co., considering that the degree of financial leverage for Everton Co. is 1?

Not enough information given

More risky

Less risky

Expert Solution

% change in EBIT = change in EBIT / Original EBIT = 1,600 / 4,000 = 40%

% change in EPS = change in EPS / Original EPS = 48 / 115.50 = 41.56%

Hence, degree of financial leverage (DFL) = % change in EPS / % change in EBIT = 41.56% / 40% = 1.038961039 = 1.04X

Hence, the correct answer is the second option 1.04X

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The degree of operating leverage of Liverpool Co. = % change in EBIT / % change in sales = 40% / 30% = 1.33

The degree of operating leverage of Everton Co. can't be calculated as there is no information for Everton in this question. Please check if Everton Co.'s information was ever provided either in the earlier parts of this question or any other question prior to this. Based on the information in this question only, we will not be able to calculate the degree of operating leverage of Everton Co. and hence the desired comparison can't be made.

------------------------------

DFL for Liverpool = 1.04X calculated above > 1.00X = DFL of Everton Co.

Higher the degree of financial leverage (DFL), higher is the risk.

Hence, Liverpool Co. is more risky than,Everton Co.

jeff jeffy answered 1 year ago

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