Corporate Finance

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Corporate Finance

Postby rishabhhurkat » Mon Mar 07, 2016 6:47 am

Q.25% increase in sales of Irrelevant Corporation causes 50% growth in EPS If operating earnings of the company is $ 12,000 and financial leverage is 1.5. Calculate operating earnings of the company if sales increase by 10% next year
Choose one answer.
a. 15000 Incorrect
b. 14000 Correct
c. 13000 Incorrect
The correct answer is B.
Total leverage = EPS growth/sales growth.
Operating leverage (OL) = total leverage/financial leverage.
New operating income = old income *(1+ OL * sales growth)

The Steps i followed were as Follows:-

1.DTL = 2 (Change in EPS/ Change in Sales)
2. DOL = 1.33 (DTL/DFL)

3. on the basis of DOL Fixed Cost comes to 4000
4. Now as Sales rise by 10%, Contribution also Rise by 10%
5 New Contribution= 16000*1.1 = 17600
6. EBIT= Cont.-FC = 17600-4000 = 13600

So how come answer is 14000??? Please Explain.

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Re: Corporate Finance

Postby edupristine » Thu Mar 10, 2016 6:03 am

Hi Rishabh

your calculation and answer is right, but we took here the nearest one because 14000 is nearest to 13600.

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