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

c. Explain why you got the results you did in part b.

Short answer

The degree of combined leverage computed in part b is 1, because the contribution is equal to the EBT. Contribution and EBT are equal because the fixed cost of Sinclair is nil and the boswell did not include debt in its capital structure. Hence, the contribution is equal to the EBT.

Step-by-step solution

EBT

Earning before tax is computed by deducting the interest cost and the fixed cost from the contribution. If the company is not incurring any fixed cost or the interest cost, then the contribution and EBT of the company are equal.

Degree of operating leverage

Degree of operating leverage is computed by dividing the contribution with the earning before tax. If the contribution is equal to the EBT of the company, then the degree of operating leverage of the company is 1.