Illinois Tool Company's (ITC) fixed operating costs are $1,260,000 and its variable cost ratio (i.e., variable costs as a fraction of sales) is 0.70. The firm has $3,000,000 in bonds outstanding at an interest rate of 8 percent. ITC has 30,000 shares of $5 preferred stock and 150,000 shares of common stock outstanding. ITC is in the 50 percent corporate income tax bracket. Forecasted sales for next year are $9 million. What is ITC's degree of financial leverage at an EBIT level of $1,440,000.
A) 1.20
B) 1.875
C) 3.0
D) 1.60

Question

Quizplus · Accepted Answer

Solution:
DFL = $1,440,000/[$1,440,000 - 0.08($3,000,000) - $150,000/(1 - 0.5)]
= 1.60

Illinois Tool Company's (ITC) Fixed Operating Costs Are $1,260,000 and Its