Question

Breakeven point and all forms of leverage TOR 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. a. At what level of sales (in units) would the firm break even on operations (that is, EBIT $0)? b. Calculate the firm’s earnings per share (EPS) in tabular form at (1) the current level of sales and (2) a 120,000-unit sales level. c. Using the current $750,000 level of sales as a base, calculate the firm’s degree of operating leverage (DOL). d. Using the EBIT associated with the $750,000 level of sales as a base, calculate the firm’s degree of financial leverage (DFL). e. Use the degree of total leverage (DTL) concept to determine the effect (in percentage terms) of a 50% increase in TOR’s sales from the $750,000 base level on its earnings per share.

Answer 1

The provided question involves the computation of breakeven point, earnings per share, degree of operating leverage, degree of financial leverage, and the degree of total leverage for a given firm based on its sales data and financial structure.

Step-by-step explanation:

The student's question pertains to calculating various financial leverage metrics for a firm given its sales, cost structure, and capital structure. These metrics include the breakeven point on operations, earnings per share (EPS) at different sales levels, degree of operating leverage (DOL), degree of financial leverage (DFL), and the effect on EPS of a change in sales using the degree of total leverage (DTL).

To solve part (a), the breakeven point on operations, we need to find the level of sales (in units) where EBIT is $0. This is calculated by dividing the fixed operating costs by the contribution margin per unit (selling price per unit minus variable cost per unit).

In part (b), we calculate EPS by subtracting all expenses, including interest and preferred dividends, from net income and then dividing by the number of common shares outstanding.

For part (c), the DOL at the current level of sales ($750,000) is calculated by dividing the contribution margin at the current sales level by the EBIT at that sales level.

In part (d), DFL is found by dividing EBIT by EBT (Earnings Before Taxes) at the current level of sales.

Finally, part (e) involves using DTL to determine the impact of a 50% increase in sales on EPS; this is done by multiplying DOL and DFL and then applying that to the percentage change in sales to find the percentage change in EPS.