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Chapter 2: 10BP_b (page 147)

The Sterling Tire Company’s income statement for 20X1 is as follows:

STERLINE TIRE COMPANY

Income Statement

For the year ended December 31, 20X1

Sales (20,000 tires at \(60 each)

\)1,200,000

Less: variable costs (20,000 tires at \(30)

600,000

Less: fixed cost

400,000

Earnings before interest and taxes (EBIT)

\)200,000

Interest expenses

50,000

Earning before taxes (EBT)

\(150,000

Income tax expenses (30%)

45,000

Earning after taxe (EAT)

\)105,000

Given this income statement, compute the following:

b. Degree of financial leverage.

Short Answer

Expert verified

The degree of financial leverage is 1.33.

Step by step solution

01

Financial leverage

Financial leverage is computed to measure the company’s ability to meet its financial obligations.

02

Degree of financial leverage leverage

Degreeoffinancialleverage=EBITEBIT-Interest=$200,000$200,000-$50,000=1.33

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Most popular questions from this chapter

Dr. Zhivàgo Diagnostics Corp.’s income statement for 20X1 is as follows

Sales\( 2790000
Cost of goods sold1790000
Gross profits\) 1000000
Selling and administrative expenses302000
Operating profits\( 698000
Interest Expense54800
Income before tax\) 643200
Taxes 30%192960
Income after tax$ 450240

b. Assume that in 20X2, sales increase by 10 percent and cost of goods sold increases by 20 percent. The firm is able to keep all other expenses the same. Assume a tax rate of 30 percent on income before taxes. What is income after taxes and the profit margin for 20X2?

For December 31, 20X1, the balance sheet of Baxter Corporation was as follows:

Current assets

Liabilities

Cash

\(15,000

Accounts payable

\)17,000

Accounts receivable

20,000

Notes payable

25,000

Inventory

30,000

Bonds payable

55,000

Prepaid expenses

12,500

Fixed assets

Stockholder’s equity

Plant and equipment (gross)

Less: accumulated depreciation

\(255,000

51,000

Preferred stock

\)25,000

Net plant and equipment

\(204,000

Common stock

60,000

Paid in capital

30,000

Retained earnings

69,500

Total assets

\)281,500

Total liabilities and stockholder’s equity

\(281,500

Sales for 20X2 were \)245,000, and the cost of goods sold was 60 percent of sales. Selling and administrative expense was \(24,500. Depreciation expense was 8 percent of plant and equipment (gross) at the beginning of the year. Interest expense for the notes payable was 10 percent, while the interest rate on the bonds payable was 12 percent. This interest expense is based on December 31, 20X1 balances. The tax rate averaged 20 percent.

\)2,500 in preferred stock dividends were paid, and \(5,500 in dividends were paid to common stockholders. There were 10,000 shares of common stock outstanding.

During 20X2, the cash balance and prepaid expenses balances were

unchanged. Accounts receivable and inventory increased by 10 percent. A new machine was purchased on December 31, 20X2, at a cost of \)40,000. Accounts payable increased by 20 percent. Notes payable increased by 6,500andbondspayabledecreasedby12,500, both at the end of the year. The preferred stock, common stock, and paid-in capital in excess of par accounts did not change.

a. Prepare an income statement for 20X2.

In 20X2, sales increased to \(5,740,000 and the assets for that year were as follows:

Cash

\)163,000

Accounts receivable

924,000

Inventory

1,063,000

New plant and equipment

520,000

Total assets

$2,670,000

Once again compute the four ratios

b. Compute the following:

1. Accounts receivable turnover.

2. Inventory turnover.

3. Fixed asset turnover.

4. Total asset turnover.

The Holtzman Corporation has assets of 400,000,currentliabilitiesof50,000, and long-term liabilities of 100,000.Thereis40,000 in preferred stock outstanding; 20,000 shares of common stock have been issued.

a. Compute book value (net worth) per share.

b. If there is $22,000 in earnings available to common stockholders and

Holtzman’s stock has a P/E of 18 times earnings per share, what is the current

price of the stock?

c. What is the ratio of market value per share to book value per share?

A firm has sales of 3million,and10percentofthesalesareforcash.Theyear−endaccountsreceivablebalanceis285,000. What is the average collection period? (Use a 360-day year.)
See all solutions

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