Question

Given the following financial data for Boston Technology, compute the firmâs degree of combined leverage.

Assume a marginal tax rate of 40%.
2010 2011
Sales $700,000 $760,000
Fixed costs 175,000 190,000
Variable costs 406,000 448,000
EBIT 119,000 122,000
Interest 42,000 46,000
Shares outstanding 100,000 102,000

Answer 1

For year 2010

Degree of combined leverage is 3.82

For year 2011

Degree of combined leverage is 4.11

Step-by-step explanation:

Computing the degree of combined leverage of the firm with the formula stated below as:

Degree of combined leverage = Contribution margin / EBT

where

Contribution margin is computed as:

Contribution margin = Sales - Variable Cost

EBT (Earnings Before tax) is computed as:

EBT = EBIT - Interest

Now, computing the same by applying the formula:

For year 2010

Contribution margin = $700,000 - $406,000

= $294,000

EBT = $119,000 - $42,000

= $77,000

Degree of combined leverage = $294,000 / $77,000

= 3.82

For year 2011

Contribution margin = $760,000 - $448,000

= $312,000

EBT = $122,000 - $46,000

= $76,000

Degree of combined leverage = $312,000 / $76,000

= 4.11