JMC Corp. sells 500,000 bottles of its herbal soda drinks per year. Each bottle produced is sold for $0.45 and has a variable cost of $0.25. The fixed operating costs for the firm are $50,000. The corporate tax for the firm is 40%.

Requirements:

• Calculate Business Risk
• Calculate the Operating Leverage or Degree of Operating Leverage (DOL) for JMC Corp.
• JMC Corp. also wants to double its sales to 1,000,000 bottes next year. Towards that it plans to restructure its capital. It is currently financed entirely by equity of $200,000. It plans to reduce its equity 50% and borrow long-term debt of $200,000 @ 5% interest cost.
  • Calculate the new:
    • Degree of Operating Leverage (DOL),
    • Degree of Financial Leverage (DFL) and
    • Degree of Combined or Total Leverage (DCL or DTL)

Transcribed Image Text:

Leverage Handout Degree of Operating Leverage (DOL) DOL %A EBIT 4 Operating Income % A Sales A Sales Contribution Margin Sales-Variable Costs DOL = Operating Income Sales-Variable Costs - Fixed Costs Key Takeaway: DOL measures change in Operating Income w.r.t. change in Sales Degree of Financial Leverage (DFL) DFL - %AEPS EBIT % EBIT Interest Key Takeaway: DFL measures sensitivity of EPS w.r.t change in Operating Income Degree of Total (Combined) Leverage (DCL or DTL) DCL = DTL = %A Sales %AEPS = DOL* DFL (SP-VC)*Q (SP-VC)*Q-FC Interest Key Takeaway: Combines the effects Operating Leverage and Financial Leverage on EPS Leverage Handout Degree of Operating Leverage (DOL) DOL %A EBIT 4 Operating Income % A Sales A Sales Contribution Margin Sales-Variable Costs DOL = Operating Income Sales-Variable Costs - Fixed Costs Key Takeaway: DOL measures change in Operating Income w.r.t. change in Sales Degree of Financial Leverage (DFL) DFL - %AEPS EBIT % EBIT Interest Key Takeaway: DFL measures sensitivity of EPS w.r.t change in Operating Income Degree of Total (Combined) Leverage (DCL or DTL) DCL = DTL = %A Sales %AEPS = DOL* DFL (SP-VC)*Q (SP-VC)*Q-FC Interest Key Takeaway: Combines the effects Operating Leverage and Financial Leverage on EPS

Answer rating: 100% (QA)

1 Business Risk Business risk can be assessed by looking at the variability of operating income One measure is the coefficient of variation CV which i... View the full answer