Question

Smith bottling company(SBC) expects this year's sale to be $648,000.SBC's variable operating costs are 75 percent of sales and its fixed operating costs are $102,000. SBC pays interest on its debt equal to $40,000 per year and its marginal tax rate is 35 percent. SBC has no preferred stock.

a. Compute SBC's DOL, DFL, and DTL. Do not round intermediate calculations. Round your answers to two decimal places. DOL: DFL: DTL:
b. If sales turn out to be $693,360 rather than $648,000, what will be SBC's EBIT and net income? Do not round intermediate calculations. Round your answers to the nearest dollar. EBIT: $ Net income: $

Answer 1

The DOL for SBC is 2.70, the DFL is 3.00, and the DTL is 8.10. When sales increase to $693,360, the EBIT is $71,340, and the net income is $6,371.

Step-by-step explanation:

To calculate Smith Bottling Company's degree of operating leverage (DOL), degree of financial leverage (DFL), and degree of total leverage (DTL), we need to determine the company's earnings before interest and taxes (EBIT) and earnings after taxes (EAT, or net income) based on the provided sales figures and cost structure. The formulas we will use are:

• DOL = (Sales - Variable Costs) / (Sales - Variable Costs - Fixed Costs)
• DFL = EBIT / (EBIT - Interest)
• DTL = DOL * DFL

Using the data provided:

• Sales = $648,000
• Variable Costs = 75% of Sales = 0.75 * $648,000 = $486,000
• Fixed Costs = $102,000
• Interest = $40,000
• Tax Rate = 35%

First, we calculate the EBIT:

EBIT = Sales - Variable Costs - Fixed Costs = $648,000 - $486,000 - $102,000 = $60,000

Now, we calculate DOL, DFL, and DTL:

DOL = ($648,000 - $486,000) / ($648,000 - $486,000 - $102,000) = $162,000 / $60,000 = 2.70

DFL = $60,000 / ($60,000 - $40,000) = $60,000 / $20,000 = 3.00

DTL = DOL * DFL = 2.70 * 3.00 = 8.10

To calculate the EBIT and net income if sales are $693,360:

Variable Costs with new sales = 75% of $693,360 = $520,020

EBIT with new sales = Sales - Variable Costs - Fixed Costs = $693,360 - $520,020 - $102,000 = $71,340

Tax on EBIT = 35% of EBIT = 0.35 * $71,340 = $24,969

Net Income = EBIT - Interest - Taxes = $71,340 - $40,000 - $24,969 = $6,371

Rounding to the nearest dollar gives us EBIT: $71,340 and Net Income: $6,371.