A company currently sells 75,000 units annually.At this sales level,its EBIT is $4 million,and its degree of total leverage is 2.0.The firm's debt consists of $15 million in bonds with a 9.5% coupon.The company is considering a new production method which will entail an increase in fixed costs but a decrease in variable costs,and will result in a degree of operating leverage of 1.750.The president,who is concerned about the stand-alone risk of the firm,wants to keep the degree of total leverage at 2.0.If EBIT remains at $4 million,what dollar amount of bonds must be retired to accomplish this? Do not round intermediate calculations.
A) $10,418,421.05
B) $10,905,263.16
C) $9,736,842.11
D) $11,684,210.53
E) $7,497,368.42

Question

Quizplus · Accepted Answer

The degree of total leverage (DTL) is the product of the degree of operating leverage (DOL) and the degree of financial leverage (DFL). Given the new DOL of 1.750 and the desired DTL of 2.0, the DFL must be 2.0 / 1.750 = 1.143. The DFL is calculated as 1 + (Debt * Interest Rate) / EBIT. Solving for the new debt amount with the given EBIT and interest rate, the bonds to be retired are $9,736,842.11.

A Company Currently Sells 75,000 Units Annually