Kermit's Hardware's (KH)fixed operating costs are $20.8 million and its variable cost ratio is 0.30. The firm has $10 million in bonds outstanding with a coupon interest rate of 9%. KH has 200,000 shares of common stock outstanding. The firm has revenues of $32.2 million and its marginal tax rate is 40%. Compute KH's degree of total leverage.
A)26.8
B)5.5
C)29.1
D)4.7

Question

Quizplus · Accepted Answer

The degree of total leverage is calculated as follows:DTL = (1 + (1 - T) * (D/E)) / (1 - VC)where:DTL = degree of total leverageT = marginal tax rateD = debtE = equityVC = variable cost ratioIn this case, we have:T = 40%D = $10 millionE = $20.8 millionVC = 0.30Plugging these values into the formula, we get:DTL = (1 + (1 - 0.40) * (10 / 20.8)) / (1 - 0.30)DTL = (1 + 0.60 * 0.48) / 0.70DTL = 1.291 / 0.70DTL = 1.844Therefore, the degree of total leverage is 1.844, which is closest to choice A) 26.8.

Kermit's Hardware's (KH)fixed Operating Costs Are $20