A firm has sales of $10 million, variable costs of $5 million, EBIT of $2 million, and a degree of total lever

Question

. A firm has sales of $10 million, variable costs of $5 million, EBIT of $2 million, and a degree of total leverage of 3.0.

a. If the firm has not preferred stock, what are its annual interest charges?

b. If the firm wishes to reduce its degree of total leverage to 2.5 by reducing interest charges, what will be the new level of annual interest charges?

Answer 1

A)

DTL=3.0

VC=5 million

TR=10 million

EBIT=TR-TC=2 million

DTL= (TR-VC) / (EBIT - I)

3.0 = (10m-5m) / (2m-I)

2m-I=5m/3

I=2m - 5m/3 = 2m-1.67m=0.333 million

B)

DTL=2.5

I=2m - 5m/2.5=2m-2m=0