Hello k9queen!!
EBIT is a measure of a company's earning power from ongoing
operations, equal to earnings before deduction of interest payments
and income taxes, also called operating profit or operating income.
For this reason, in this case, we donīt include the annual interest
expense of $90,000 to calculate the EBIT.
EBIT = ($10.00 * 150,000) - ($6.50 * 150,000) - $155,000 =
= $1,500,000 - $975,000 - $155,000 =
= $370,000 .
To the question 7 the correct answer is a) $370,000 .
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Operating leverage measures the effect of fixed costs on the firm, and
that the degree of operating leverage (DOL) equals:
% change in EBIT change in EBIT / EBIT
DOL = -------------------- = ----------------------------- [eq 1]
% change in sales change in sales / sales
This results in:
DOL = [q * (p - v)] / [q * (p - v) - f] =
= [(q * p) - (q * v)] / EBIT =
= (Sales - Variable costs) / EBIT [eq 1a]
where:
q = quantity; p = price per unit; v = variable cost per unit; and
f = total fixed costs
DOL = 150,000 * ($10-$6.50) / (150,000 * ($10-$6.50) - $155,000) =
= $525,000 / ($525,000 - $155,000) =
= $525,000 / $370,000 =
= 1.42
The correct answer to the question 8 is c) 1.42 .
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If the sales increases 20%, ABC will sell 150,000 * 1.20 = 180,000
units.
The fixed costs stay invariable at $155,000 .
The new EBIT is:
EBIT = ($10 * 180,000) - ($6.5 * 180,000) - $155,000 =
= $1,800,000 - $1,170,000 - $155,000 =
= $475,000 .
The ratio between the new and old EBIT is:
$475,000 / $370,000 = 1.28 , there is a change of 28% .
So the answers for questions 9) and 10) are b)28% and d)$475,000
(?)respectively.
There is no problem with the answer 9), but I am wonder about the
difference of $2,000 in the answer 10).
After burn my brain looking for an explanation I found two:
A)There is a typo.
B)The way for calculations is different and it drags rounded errors.
The other way to find the solution is:
From the [eq 1] we have that:
%change in EBIT = % change in sales * DOL = 20 * 1.42 = 28.4%
= (rounded) 28%
Then,
New EBIT = 1.28 * Old EBIT = 1.28 * $370,000 =
= $473,600 (that is very closer to the proposed result of
473,000).
But I think that my first answer is "more" correct.
PLEASE LET ME KNOW YOUR OPINION ABOUT THIS, IF YOU ARE NOT SATISFIED I
WILL CONTINUE SEARCH FOR ANOTHER RESOLUTION.
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% change in EPS change in EPS / EPS
DFL = -------------------- = ----------------------------- [eq 2]
% change in EBIT change in EBIT / EBIT
EPS = (EBIT - I) / S
where S is the amount of shares outstanding, and I is the annual
interest expense.
% change in EPS = change in EPS / EPS =
= (EPS2 - EPS) / EPS =
= ((EBIT2 - I) - (EBIT - I)) / (EBIT - I) * S/S =
= (EBIT2 - EBIT) / (EBIT - I) =
= change in EBIT / (EBIT - I) [eq 3]
Combining [eq 2] with [eq 3] we obtain:
% change in EPS change in EBIT / (EBIT - I)
DFL = -------------------- = ------------------------------- =
% change in EBIT change in EBIT / EBIT
= EBIT / (EBIT - I) [eq 4]
Now we can use the equation 4:
DFL = $370,000 / ($370,000 - $90,000) = $370,000/$280,000 = 1.32 .
The correct answer for the question 11) is c) 1.42 .
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DCL = DOL * DFL
From here is easy to obtain by replacing the following equation:
DCL = = %change in EPS / %change in sales [eq 5]
DCL = 1.42 * 1.32 = 1.87
The correct answer for the question 12) is d) 1.87 .
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From the [eq 2] we have:
% change in EPS = DFL * % change in EBIT = 1.32 * 28 = 37%
We also can use the equation 5:
% change in EPS = DCF * %change in sales = 1.87 * 20 = 37%
The correct answer for the question 13) is c) 37% .
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We know that for an increase of 20% in units sold we have a 37% of
increase in the EPS.
If the initial EPS is $2.00, when the sales will increase a 20% the
new EPS will be:
$2.00 * 1.37 = $2.74 .
The correct answer for the question 14) is a) $2.74 .
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I hope this helps. If you need a clarification, specially about the
question 10, please feel free to post a request for it.
Best Regards.
livioflores-ga |
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