TCA Cable has fixed operating costs of $2.6 million, and its variable cost ratio is 0.30. TCA has $4.0 million in bonds outstanding with a coupon interest rate of 12%. TCA has 1.0 million common shares and 1,000,000 shares of $1.75 preferred stock outstanding. Total revenues for TCA Cable are $14.2 million. If TCA has a marginal tax rate of 40%, what is its degree of combined leverage?
A) 2.1
B) 1.0
C) 1.9
D) 2.5

Question

Quizplus · Accepted Answer

The degree of combined leverage (DCL) is calculated using the formula: DCL = DOL * DFL, where DOL is the degree of operating leverage and DFL is the degree of financial leverage. First, calculate the EBIT (Earnings Before Interest and Taxes):Total Revenues = $14.2 millionVariable Costs = Total Revenues * Variable Cost Ratio = $14.2 million * 0.30 = $4.26 millionEBIT = Total Revenues - Variable Costs - Fixed Operating Costs = $14.2 million - $4.26 million - $2.6 million = $7.34 millionNext, calculate the degree of operating leverage (DOL) at the current level of output:DOL = % Change in EBIT / % Change in Sales = [EBIT / (EBIT - Fixed Operating Costs)] = $7.34 million / ($7.34 million - $2.6 million) = $7.34 million / $4.74 million ≈ 1.55Then, calculate the degree of financial leverage (DFL):DFL = % Change in EPS / % Change in EBIT = [EBIT / (EBIT - Interest)] = $7.34 million / ($7.34 million - Interest Expenses)Interest Expenses = $4.0 million * 12% = $0.48 millionDFL = $7.34 million / ($7.34 million - $0.48 million) = $7.34 million / $6.86 million ≈ 1.07Finally, calculate the degree of combined leverage (DCL):DCL = DOL * DFL = 1.55 * 1.07 ≈ 1.66However, given the options provided and the calculations, it seems there might be a misunderstanding in the calculation process or the interpretation of the given options. The correct calculation involves understanding the impact of both operating and financial leverage on earnings per share for a given change in sales, but the provided options do not match the calculated result. Given the discrepancy, the closest match or the intended calculation method might differ from the standard approach. Without further information or clarification, the precise answer according to standard financial analysis is not listed among the provided options.

TCA Cable Has Fixed Operating Costs of $2