DeSoto Tools Inc. plans to expand production. The expansion will cost $2,600,000, which can be financed with bonds at an interest rate of 7 percent or by selling 52,000 common shares at $50 per share. The current income statement before the expansion is as follows:

DeSoto Tools Inc. Income Statement 20X1
Sales.	ps	3,060,000
Variable costs		1,224,000
Fixed costs		806,000
Earnings before interest and taxes	ps	1,030,000
Interest expenses		460.000
earnings before taxes	ps	570.000
Taxes @ 40%		228,000
profit after tax	ps	342,000
share		160.000
earnings per share	ps	2.14

After the expansion, sales are expected to increase to $1,560,000. Variable costs will remain at 40 percent of sales and fixed costs will increase to $1,362,000. The tax rate is 40 percent.

Required

a. Calculate the degree of operating leverage, the degree of financial leverage, and the degree of combined leverage before the expansion. (For the degree of operating leverage, use the formula: DOL = ( S − TVC) / ( S − TVC − FC). For the degree of combined leverage, use the formula: DCL = ( S − TVC) / ( S − TVC − FC − I. These instructions apply throughout this problem.)

b. Construct the income statement for the two alternative financing plans.

C. Calculate the degree of operating leverage, the degree of financial leverage, and the degree of combined leverage, after the expansion. 

Answer rating: 100% (QA)

SOLUTION a Before the expansion the degree of operating leverage DOL can be calculated as DOL S TVC ... View the full answer