1. The Hurricane Lamp Company forecasts that next year's sales will be $6 million. Fixed operating costs are estimated to be $800,000, and the variable cost ratio (that is, variable costs as a fraction of sales) is estimated to be 0.75. The firm has a $600,000 loan at 10 percent interest. It has 20,000 shares of $3 preferred stock and 60,000 shares of common stock outstanding. Hurricane Lamp is in the 40 percent corporate income tax bracket.
a. Forecast Hurricane Lamp's earnings per share (EPS) for next year. Develop a complete income statement using the revised format illustrated in Table 14.1. Then determine what Hurricane Lamp's EPS would be if sales were 10 per- cent above the projected $6 million level.
b. Calculate Hurricane Lamp's degree of operating leverage (DOL) at a sales level of $6 million using the following:
i. The definitional formula (Equation 14.1)
ii. The simpler, computational formula (Equation 14.2)
iii. What is the economic interpretation of this value?
c. Calculate Hurricane Lamp's degree of financial leverage (DFL) at the EBIT level corresponding to sales of $6 million using the following:
i. The definitional formula (Equation 14.3)
ii. The simpler computational formula (Equation 14.4)
iii. What is the economic interpretation of this value?
d. Calculate Hurricane Lamp's degree of combined leverage (DCL) using the following:
i. The definitional formula (Equation 14.5)
ii. The simpler computational formula (Equation 14.7)
iii. The degree of operating and financial leverage calculated in parts b and c
iv. What is the economic interpretation of this value?
Text Book: Contemporary Financial Management By R. Charles Moyer, James McGuigan, Ramesh Rao.