Assume that the Samsung Corporation has $2 million in sales (S), with variable c
ID: 2622352 • Letter: A
Question
Assume that the Samsung Corporation has $2 million in sales (S), with variable costs (VC) being equal to 70% of its sales, its fixed costs (F) are $100,000, and its annual long-term interest expense (I) is $50,000. Show all calculations.
Question 1: Determine Samsung's degree of operating leverage (DOL). Check figure: DOL = 1.2. Hint: Use equation 13A-2a.
Question 2: Determine Samsung's degree of financial leverage (DFL). Hint: Use equation 13A-3.
Question 3: If Samsung's operating income (EBIT) increases by 20%, by what percent will its net income increase? Check figure: NI will increase by 22.22%. Hint: You can use the DFL to help answer this.
Question 4: Determine Samsung's degree of total leverage (DTL). Check figure: DTL = 1.3333.
Question 5: If Samsung's sales increase by 15%, by what percent will the company's net income increase? Answer this question independently of question 3. Hint: You can use the DTL to help answer this.
Question 6: Determine Samsung's DFL if it had no long-term debt.
Explanation / Answer
1) DOL = ( S - VC) / ( S - VC - FC ) = ( 2000000 -0.7*2000000) / ( 2000000 -0.7*2000000 - 100000) = 1.2
2) DFL = ( S - VC) / ( S - VC - FC - I ) = ( 2000000 -0.7*2000000 - 100000) / ( 2000000 -0.7*2000000 - 100000 - 50000) = 1.1
3) DFL = % Change in NI / % Change in EBIT = 1.1111
% Change in NI = 1.11 * % Change in EBIT = 1.1120% = 22%
4)DTL = DFL * DOL = 1.1111 * 1.2 = 1.3333
5)DTL = % Change in NI / % Change in Sales = 1.3333
% Change in NI = 1.3333 * % Change in Sales = 1.333 * 15% = 19.9995%
6)No Long term debt implies I = 0
DFL = EBIT / ( EBIT - I ) = EBIT / EBIT = 1