Question

Firms in Japan often employ both high operating and financial leverage because of the use of modern technology and close borrower–lender relationships. Assume the Mitaka Company has a sales volume of 130,000 units at a price of \(30 per unit; variable costs are \)10 per unit, and fixed costs are \(1,850,000. Interest expense is \)405,000. What is the degree of combined leverage for this Japanese firm?

Short answer

The degree of combined leverage of the company is 7.54.

Step-by-step solution

Contribution

$\begin{array}{rcl}\mathrm{Contribution}& =& \mathrm{Quantity}\times \left(\mathrm{Sales}\mathrm{price}\mathrm{per}\mathrm{unit}-\mathrm{Variable}\mathrm{cost}\mathrm{per}\mathrm{unit}\right)\\ & =& 130,000\times \left(\$30-\$10\right)\\ & =& \$2,600,000\end{array}$

EBT

$\begin{array}{rcl}\mathrm{EBT}& =& \mathrm{Contribution}-\mathrm{Fixed}\mathrm{cost}-\mathrm{Interest}\\ & =& \$2,600,000-\$1,850,000-\$405,000\\ & =& \$345,000\end{array}$

Degree of combined leverage

$\begin{array}{rcl}\mathrm{Degree}\mathrm{of}\mathrm{combined}\mathrm{leverage}& =& \frac{\mathrm{Contribution}}{\mathrm{EBT}}\\ & =& \frac{\$2,600,000}{\$345,000}\\ & =& 7.54\end{array}$