Problem 1: Albatross Airline's fixed operating costs are $5.8 million, and its variable cost interest rate is 0.20. The firm has $2 million in bonds outstanding with a coupon interest rate of 8 percent. Albatross has $30,000 shares of preferred stock outstanding, which pays a $2 annual dividend. There are 100,000 shares of common stock outstanding. Revenues for the firm are $8 million, and the firm is in the 40 percent corporate income tax bracket.
a) Compute Albatross' degree of operating leverage.
b) Compute its degree of financial leverage.
c) Compute its degree of combined leverage and interpret this value.
Problem 2: Fastron, Inc. expects sales of silicon chips to be $60 million this year. Because this is a very capital-intensive business, fixed operating costs are $20 million. The variable cost ratio is 40 percent. The firm's debt obligations consist of a $4 million, 10 percent bank loan and a $20 million bond issue with an 11 percent coupon rate. Fastron has 1 million shares of common stock outstanding, and its marginal tax rate is 40 percent.
a) Compute Fastron's degree of operating leverage.
b) Compute Fastron's degree of financial leverage.
c) Compute Fastron's degree of combined leverage.
d) Compute Fastron's EPS if sales decline by 5 percent.