Question

Sinclair Manufacturing and Boswell Brothers Inc. are both involved in the production of brick for the homebuilding industry. Their financial information is as follows:

Capital Structure
	Sinclair	Boswell
Deb @11%	\(900,000	0
Common stock, \)10 per share	600,000	\(1,500,000
Total	\)1,500,000	\(1,500,000
Common shares	60,000	150,000
Operating plans
Sales (55,000 units at \)20 each)	\(1,100,000	\)1,100,000
Less: variable cost	880,000 (\(16 per unit)	550,000 (\)10 per unit)
Fixed cost	0	305,000
Earnings before interest and taxes (EBIT)	\(220,000	\)245,000

b. If you combine Boswell’s capital structure with Sinclair’s operating plan, what is the degree of combined leverage?

Short answer

The degree of combined leverage of both the companies is 1.

Step-by-step solution

Contribution

$\begin{array}{rcl}\mathrm{Contribution}& =& \mathrm{Quantity}\times \left(\mathrm{Sales}\mathrm{price}\mathrm{per}\mathrm{unit}-\mathrm{Variable}\mathrm{cost}\mathrm{per}\mathrm{unit}\mathrm{of}\mathrm{Sinclair}\right)\\ & =& 55,000\times \left(\$20-\$16\right)\\ & =& \$220,000\end{array}$

EBT

$\begin{array}{rcl}\mathrm{EBT}& =& \mathrm{Contribution}-\mathrm{Fixed}\mathrm{cost}\mathrm{of}\mathrm{Sinclair}-\mathrm{Interest}\mathrm{of}\mathrm{boswell}\\ & =& \$220,000-\$0-\$0\\ & =& \$220,000\end{array}$

Degree of combined leverage of both companies

$\begin{array}{rcl}\mathrm{Degree}\mathrm{of}\mathrm{combined}\mathrm{leverage}& =& \frac{\mathrm{Contribution}}{\mathrm{EBT}}\\ & =& \frac{\$220,000}{\$220,000}\\ & =& 1\end{array}$