Operating and financial leverage
annual sales are $3.0 million (30 sailboats at $100,000 each). Because of the
need to be near the ocean, the company’s fixed costs are high, $1.0 million.
The variable cost ratio is 30 percent. The owner, Stan, has financed the
business with $1.2 million bank loan at 7 percent and has sold shares of common
stock in the business to family members. Currently, there are 10,000 shares
outstanding. Seaside ‘s tax rate is 40 percent.
1. Compute Seaside ‘s degree of operating leverage.
2. Compute Seaside ‘s degree of financial leverage.
3. Compute Seaside ‘s degree of combined leverage.
4. Compute pre-tax earnings per share.
5. Compute pre-tax earnings per share if sales decreased by 10 percent.
6. Compute earnings per share if sales increased by 10 percent.
7. Comment on the impact of decreased and increased sales on earnings. What insight can you gain from this analysis?
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