McGonnigal, Inc., has expected sales of $40 million. Fixed operating costs are $5 million, and the variable cost ratio is 65 percent. McGonnigal has outstanding a $10 million, 10 percent bank loan and $3 million in 12 percent coupon-rate bonds. McGonnigal has outstanding 250,000 shares of a $10 (dividend) preferred stock and 1 million shares of common stock ($1 par value). McGonnigal’s average tax rate is 35 percent, and its marginal rate is 40 percent.

a. What is McGonnigal’s degree of operating leverage at a sales level of $40 million?

b. What is McGonnigal’s current degree of financial leverage?

c. Forecast McGonnigal’s EPS if sales drop to $38 million.