Leverage/Finance Question?

Question

Albatross Airline’s fixed operating costs are $5.8 million, and its variable cost ratio is 0.20. The firm has$2 million in bonds outstanding with a coupon interest rate of 8 percent. Albatross has 30,000 shares of preferred stock outstanding, which pays a $2 annual dividend? There are 100,000 shares of common stock outstanding. Revenues for the firm are $8 million, and the firm is in the 40 percent corporate income tax bracket.

a. Compute Albatross’ degree of operating leverage.

b. Compute its degree of financial leverage.

c. Compute its degree of combined leverage and interpret this value.

Need some help quickly. Thanks.

Answer 1

TR=$8m

VC ratio=0.2

VC=$8m*0.2=$1.6m

FC=$5.8m

TC=FC+VC

TC=5.8+1.6=7.4

Left=8-1.6-5.8=8-7.4=$0.6m

a)

EBIT=TR-VC-FC=0.6m

DOL= (TR-VC)/(EBIT) = (8-1.6)/(8-1.6-5.8)=6.4/0.6=10.67

b)

DFL=EBIT/(EBIT-I)

I-interest

30'000*2=60'000

2m*0.08=160'000

I=60'000+160'000=220'000

DFL=600/(600-220)=600/380=1.58

c)

DTL=DFL*DOL=1.58*10.67=16.84

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