Question 1: The Harding Company manufactures skates. The company's income statement for 2001 is as follows:
HARDING COMPANY
Income Statement For the Year Ended December 31, 2001
Sales (10,000 skates @ $50 each) $500,000
Less: Variable costs (10,000 skates at $20) 200,000
Fixed costs 150,000
Earnings before interest and taxes (EBIT) 150,000
Interest expense 60,000
Earnings before taxes (EBT) 90,000
Income tax expense (40%) 36,000
Earnings after taxes (EAT) 54,000
Given this income statement, compute the following:
a. Degree of operating leverage
b. Degree of financial leverage
c. Degree of combined leverage
d. Break-even point in units (number of skates)
Question 2: Cain Auto Supplies and Able Auto Parts are competitors in the aftermarket for auto supplies. The separate capital structures for Cain and Able are presented below.
CAIN ABLE
Debt @ 10% $ 50,000 Debt @ 10% $100,000
Common stock, $10 par 100,000 Common stock, $10 par 50,000
Total $150,000 Total $150,000
Common shares 10,000 Common shares 5,000
a. Compute earnings per share if earnings before interest and taxes are $10,000, $15,000, and $50,000 (assume a 30 percent tax rate)
b. Explain the relationship between earnings per share and the level of EBIT
c. If the cost of debt went up to 12 percent and all other factors remained equal, what would be the break-even level for EBIT?