50.1K

Verified Solution

Link Copied!

Q.

1. DeSoto Tools Inc. is planning to expand production. The expansion will cost $4,400,000, which can be financed either by bonds at an interest rate of 6 percent or by selling 88,000 shares of common stock at $50 per share. The current income statement before expansion is as follows: [Marks 11]

DeSoto Tools Inc. Income Statement 202X

Sales. Rs. 3,260,000

Variable costs 1,304,000

Fixed costs 824,000

Earnings before interest and taxes $ 1,132,000

Interest expense 640,000

Earnings before taxes Rs. 492,000 Taxes (@ 40%) 196,800

Earnings after taxes Rs. 295,200

Shares 340,000

Earnings per share Rs. 0.87

After the expansion, sales are expected to increase by $1,740,000. Variable costs will remain at 40 percent of sales, and fixed costs will increase to $1,398,000. The tax rate is 40 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. (Input all amounts as positive values. 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.)

Please solve the above question i n proper steps. Hoping for a quick reply :)

Answer & Explanation Solved by verified expert

See Answer