Calculate the EPS & DFL for each financing plan (i.e. 4 calculations). Total funding needed...

Question:

Calculate the EPS & DFL for each financing plan (i.e. 4 calculations).

Plan A Plan B
i ii i ii
Total Funding Needed
Debt
Equity
EBIT 10,000 30,000 10,000 30,000

Total funding needed $350,000

Interest rate on debt 6.5%

Common stock price per share $15

Plan A Debt 30%

Plan B Debt 60%

Tax rate 35%

Degree of financial leverage

The degree of financial leverage (DFL) measures the sensitivity of how to fluctuate the operating income of the company caused the changes in its capital structure. It is the common method to quantify the financial risk of the business.

DFL can be calculated as:

DFL = EBIT/(EBIT - interest)

Answer and Explanation:

  • Total funding needed $350,000
  • Interest rate on debt 6.5%
  • Common stock price per share $15
  • Plan A Debt 30%
  • Plan B Debt 60%
  • Tax rate 35%

 

Plan A

Plan B

 

i

ii

i

ii

Total Funding Needed

$ 350,000

$ 350,000

$ 350,000

$ 350,000

Debt

$ 105,000

$ 105,000

$ 210,000

$ 210,000

Equity

$ 245,000

$ 245,000

$ 140,000

$ 140,000

EBIT

10,000

30,000

10,000

30,000

Less, Interest @6.5%

$ 6,825

$ 6,825

$ 13,650

$ 13,650

Profit before tax

$ 3,175

23,175

-3,650

16,350

Tax@35%

$ 1,111

8,111

0

5,723

Net Profit

$ 2,064

$ 15,064

-$ 3,650

$ 10,628

Common stock price

$ 15

$ 15

$ 15

$ 15

No of shares o/s

16,333

16,333

9,333

9,333

EPS = Net profit/No of shares

$ 0.13

$ 0.92

-$ 0.39

$ 1.14

DFL = EBIT/(EBIT-Interest)

3.15

1.29

-2.74

1.83


Learn more about this topic:

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Financial Risk: Types, Examples & Management Methods

from Finance 305: Risk Management

Chapter 1 / Lesson 4
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