You and your colleague madison are currently participating in a finance internship program at carter chemical company. Your current assignment is to work together to review carters current and projected income statements. You will also assess the consequences of management's capital structure and investment decisions of the firms future riskiness. After much discussion, you and madison decide to calculate carter's degree of operating leverage (DOL), degree of financial leverage (DFL), and degree of total leverage (DTL) based on this year's data to gain insights into carter's risk levels.
The most recent income statement for Carter Chemical Company follows. Carter is funded solely with debt capital and common equity, and it has 2,000,000 shares of common stock currently outstanding.
Sales: This year: $60,000,000 Next Years Projection: $64,500,000
Less: Variable Costs This year: $36,000,000 Next Years Projection: $38,700,000
Gross Profit This year: $24,000,000 Next Years Projection: $25,800,000
Less: Fixed Operating costs This year: $12,000,000 Next Years Projection: $12,000,000
Net Operating Income (EBIT) This year: $12,000,000 Next Years Projection: $13,800,000
Less: Interest Expense This year: $1,200,000 Next Years Projection: $1,200,000
Taxable Income (EBT) This year: $10,800,000 Next Years Projection: $12,600,000
Less: Tax Expense (40%) This year: $4,320,000 Next Years Projection: $5,040,000
Net Income This year: $6,480,000 Next Years Projection: $7,560,000
Earnings Per Share (EPS) This year: $3.24 Next Years Projection: $3.78
Given this info, complete the following table and then answer the questions that follow. When performing your calculations, round your EPS and percentage change values to two decimal places.
Carter Chemical Company Date:
Questions:
DOL (Sales = $60,000,000) Answer: A. 7.5 B. 2.0 C. 2.5
DFL (EBIT = $12,000,000) Answer: A. 2.0 B. 1.11 C. 1.87
DTL (Sales = $60,000,000) Answer: A. 2.0 B. 2.22 C. 16.67
Everything else remaining constant, assume Carter Chemical Company decides to sell 520,000 shares of preferres stock that would pay $4 per share per year in cash dividends. How would this affect Carter's DOL, DFL, and DCL?
Questions:
DOL would be expected to : A. Decrease B. Increase C. Remain Constant
DFL would be expected to : A. Decrease B. Increase C. Remain Constant
DTL would be expected to : A. Decrease B. Increase C. Remain Constant