A firm has earnings before interest and tax of $1,000,000, interest of $200,000, and net income of $400,000 in Year 1.
Required:
a. Calculate the degree of financial leverage in base Year 1.
b. If earnings before interest and tax increase by 10% in Year 2, what will be the new level of earnings, assuming the same tax rate as in Year 1?
c. If earnings before interest and tax decrease to $800,000 in Year 2, what will be the new level of earnings, assuming the same tax rate as in Year 1?