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DeSoto Tools Inc. is planning to expand production. The expansion will cost $3,100,000, which can be financed either by bonds at an interest rate of 9 percent or by selling 62,000 shares of common stock at $50 per share. The current income statement before expansion is as follows:

DESOTO TOOLS INC. Income Statement 20X1
Sales	$	3,110,000
Variable costs		933,000
Fixed costs		811,000
Earnings before interest and taxes	$	1,366,000
Interest expense		510,000
Earnings before taxes	$	856,000
Taxes @ 35%		299,600
Earnings after taxes	$	556,400
Shares		210,000
Earnings per share	$	2.65

After the expansion, sales are expected to increase by $1,610,000. Variable costs will remain at 30 percent of sales, and fixed costs will increase to $1,372,000. The tax rate is 35 percent.

a. Calculate the degree of operating leverage, the degree of financial leverage, and the degree of combined leverage before 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.) (Round your answers to 2 decimal places.)

b. Construct the income statement for the two alternative financing plans. (Round EPS to 2 decimal places.)

c. Calculate the degree of operating leverage, the degree of financial leverage, and the degree of combined leverage, after expansion. (Round your answers to 2 decimal places.)

Answer is complete and correct. Degree of operating leverage Degree of financial leverage Degree of combined leverage 1.59 1.59 2.54 b. Construct the income statement for the two alternative financing plans. (Round EPSS to 2 decimal places.) Answer is not complete. $ Sales Variable costs Fixed costs Earnings before interest and taxes Interest Earnings before taxes Taxes Earnings after taxes Common shares Debt 3,100,000 $ 141,600 137,200 2,821,200 279,000 2,542,200 Equity 3,100,000 141,600 % 137,200 2,821,200 0 X 2,821,200 2,542,200 2,821,200 Earnings per share c. Calculate the degree of operating leverage, the degree of financial leverage, and the degree of combined leverage, after expansion. (Round your answers to 2 decimal places.) Answer is complete but not entirely correct. Degree of operating leverage Degree of financial leverage Degree of combined leverage Debt 1.71 1.17 2.00 Equity 1.71 1.00 1.71 %

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