The Hurricane Lamp Company forecasts that next years sales will be $6 million. Fixed operating costs are
Question:
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 percent 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?
Common stock is an equity component that represents the worth of stock owned by the shareholders of the company. The common stock represents the par value of the shares outstanding at a balance sheet date. Public companies can trade their stocks on...
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Contemporary Financial Management
ISBN: 9780324289114
10th Edition
Authors: James R Mcguigan, R Charles Moyer, William J Kretlow