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You and your colleague, Maya, are currently participating in a finance internship program at Tucker Manufacturing
You and your colleague, Maya, are currently participating in a finance internship program at Tucker Manufacturing. Your current assignment is to work together to review Tucker’s current and projected income statements. You will also assess the consequences of management’s capital structure and investment decisions on the firm’s future riskiness. After much discussion, you and Maya decide to calculate Tucker’s degree of operating leverage (DOL), degree of financial leverage (DFL), and degree of combined leverage (DCL) based on this year’s data to gain insights into Tucker’s risk levels.
The most recent income statement for Tucker Manufacturing follows. Tucker is funded solely with debt capital and common equity, and it has 3,000,000 shares of common stock currently outstanding.
|
This Year’s Data |
Next Year’s Projected Data |
|
|---|---|---|
| Sales | $40,000,000 | $43,200,000 |
| Less: Variable costs | 20,000,000 | 21,600,000 |
| Gross profit | 20,000,000 | 21,600,000 |
| Less: Fixed operating costs | 8,000,000 | 8,000,000 |
| Net operating income (EBIT) | 12,000,000 | 13,600,000 |
| Less: Interest expense | 800,000 | 800,000 |
| Taxable income (EBT) | 11,200,000 | 12,800,000 |
| Less: Tax expense (40%) | 4,480,000 | 5,120,000 |
| Net income | $6,720,000 | $7,680,000 |
| Earnings per share (EPS) | $2.24 | $2.56 |
Given this information, complete the following table and then answer the questions that follow. When performing your computations, round your EPS value and the percentage change values to two decimal places.
|
Tucker Manufacturing Data |
|
|---|---|
| DOL (Sales = $40,000,000) | ________? |
| DFL (EBIT = $12,000,000) | ________? |
| DCL (Sales = $40,000,000) | ________? |
Everything else remaining constant, assume Tucker Manufacturing decides to immediately repay 50% of a bank loan prior to its maturity. How would this affect Tucker’s DOL, DFL, and DCL?
| • | The DOL would be expected to _________? . |
| • | The DFL would be expected to _________? . |
| • | The DCL would be expected to _________? . |
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