harding company manufactures skates. the company's income statement
for 2001 is a follow.

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Clarification of Question by jatan-ga on 13 Aug 2005 12:50 PDT

The Harding Company manufactures skates. the company's income
statement for the 2001 is as follows:
Harding Company
Income Statement
For the year ended december 31, 2001
Sales (10,000 skates @ $50 each) ............$500,000
 Less: Variable costs (10,000 skates at $20..$200,000
  Fixed Costs ............................... 150,000
-----------------------------------------------------
Earnings before interest and taxes (EBIT).... 150,000
Interest expense.............................  60,000
-----------------------------------------------------
Earnings before taxes (EBT)..................  90,000
Income tax expense (40%).....................  36,000
-----------------------------------------------------
Earnings after taxes (EAT)...................$ 54,000


Given this income statement, compute the following:
1. Degree of operating leverage.
2. Degree of fianancial leverage.
3. Degree of combined leverage.
4. Break-even point in units( numbers of skates).

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Clarification of Question by jatan-ga on 13 Aug 2005 14:21 PDT

Can I get an answer to this?

Hi!!


1. Degree of operating leverage.

Degree of operating leverage (DOL):
- It measures the EBIT's percentage change as a result of a change of
one percent in the level of output.
- It helps in measuring the business risk.

To compute it just use the following formula:
Degree of operating leverage = Sales revenue less total variable cost
divided by sales revenue less total cost:

DOL = (Sales-Variable Costs) / (Sales-Variable Costs-Fixed Costs)

For this problem:

DOL = ($500,000-$200,000) / ($500,000-$200,000-$150,000) =
    = $300,000 / $150,000 =
    = 2

                 ----------------

2. Degree of financial leverage.

The degree of financial leverage (DFL) is defined as the percentage
change in earnings per share [EPS] that results from a given
percentage change in earnings before interest and taxes (EBIT):

DFL = Percentage change in EPS divided by Percentage change in EBIT

The above equation can be worked to get the following equivalent one:

DFL = EBIT / (EBIT-I), where I is the interest expense.

For this problem:
DFL = $150,000 / ($150,000-$60,000) =
    = $150,000 / $90,000 =
    = 5/3 = 1.67

                 ----------------

3. Degree of combined leverage.

The degree of combined leverage is also known as degree of total leverage (DTL). 

To compute it use the following formula:
DCL = DOL * DFL

For this problem:
DCL = 2 * 5/3 = 10/3 = 3.333

                --------------------

4. Break-even point in units( numbers of skates).

Break-even point in Units = Fixed Costs / Contribution margin per unit 

where:
Contribution margin per unit = (Revenues - Variable Costs) / Units sold =
                             = Price per unit - Variable cost per unit

In effect:
The break-even level of sales is the sales point at which EBIT = 0 ;
or in other words:
break-even point in units = level of sales necessary to cover operating costs.

At the break-even level of sales:
EBIT = Sales - Variable costs - Fixed costs = 0 
then:
Sales - Variable costs = Fixed costs

If we call:
q = quantity sold; 
p = price per unit; 
v = variable cost per unit, 
then
Revenues = q.p   and   Variable costs = q.v   

We will have:
Revenues - Variable costs = q.p - q.v = q.(p - v) 

Then for the break-even point is:
q.(p - v) = Fixed costs ==> q = Fixed costs / (p - v) 


For this problem is:
Variable costs per unit = $20

Contribution margin per unit = Price per unit - Variable cost per unit =
                             = $50 - $20 =
                             = $30

Break-even point in Units = Fixed Costs / Contribution margin per unit =
                          = $150,000 / $30 =
                          = 5,000 

The  break even point in units is 5,000 skates.

------------------------------------------------------

For references see:
"Operating and Financial Leverage" (Ms Powerpoint presentation):
http://wps.pearsoned.co.uk/wps/media/objects/1670/1710211/0273685988_ch16.ppt


"Introduction to Capital Structure":
http://cbdd.wsu.edu/kewlcontent/cdoutput/TR505r/page22.htm


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Search strategy:
I used my own knowledge to answer this question, to find the
references I used the following search terms in Google:
"financial leverage"
"operating leverage"
"combined leverage"


I hope that this helps you. Feel free to request for a clarification
if you need it.

Regards,
livioflores-ga

Your question need to be completed, and also suggest you to raise its price.