McMichael, Inc has expected sales of $40 million. Fixed operating cost is $5 mil
ID: 2770032 • Letter: M
Question
McMichael, Inc has expected sales of $40 million. Fixed operating cost is $5 million and the variable cost ratio is 65 percent. They have outstanding debt of $10 million at an interest rate of 10 percent and $3million in a 12 percent bond. McMichael has 250,000 shares of preferred stock with a $10 dividend and 1 million shares of outstanding common stock. Their average tax rate is 35% and marginal tax rate is 40%. (15 points)
What is the company’s DOL at its current sales level. What is their current DFL? Forecast McMichael’s EPS if sales drop to $38 million.
Explanation / Answer
DOL =( Sales -Variables cost)/(Sales - fixed cost- variable cost)
= (40 Mn- .65*40)/(40-5-.65*40-5)
=14/9=1.56
DFL = EBIT /(EBIT -Interst)
Interest = 10*.1 + 3 *.12
=1 + 0.36
=1.36
EBIT = 9
EBIT - Interest = 7.64
DFL = 1.178
If the sales drop to 38
Sales 38 Fixed cost 5 Variable cost 24.7 Interest 1.36 PBT 6.94 Tax 2.776 Pat 4.164 Shares o/s 1 EPS 4.164