### Calculate degree of financial leverage

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##### Reference no: EM132234817

1.) A firm has the following information for the last two years. Calculate its degree of financial leverage.

This year Last year

Sales \$1,500,000 \$1,300,000

Operating costs \$900,000 \$800,000

Net income \$150,000 \$120,000

Number of shares outstanding 50,000 50,000

2.) Allegra Inc. has one million shares outstanding. The company is considering the issue of debt of \$15 million. The interest rate on this new debt issue will be 8%, and the number of shares after the debt issue will be reduced to 500,000. Given a corporate tax rate of 40%, what is the EBIT that will cause the firm's earnings per share to be indifferent between issuing and not issuing debt?

3.) Mrs. Abecrombus has \$2,000 to invest. There are only two possible investments: a levered firm with a D/E ratio of 1 and a share price of \$20, and a risk-free asset with a return of 10%. If Mrs. Abecrombus prefers a D/E ratio of 2, how can she use homemade leverage to achieve her goal?

Select one:

a. borrow \$2,000 at the risk-free rate and buy 200 shares

b. lend \$2,000 at the risk-free rate and sell 100 shares

c. lend \$1,000 at the risk-free rate and sell 50 shares

d. borrow \$1,500 at the risk-free rate and buy 175 shares

e. borrow \$1,000 at the risk-free rate and buy 150 shares

4.) Async Inc. and Sync Corp. both have the same EBIT of \$3 million and tax rate of 30%. Async is all-equity financed with a cost of capital of 12%, whereas Sync has debt of \$7.5 million. What is Sync's firm value using the M&M Proposition?

5.) You are a business analyst with a big investment bank, and you are evaluating the equity risk, business risk, and financial risk of Abilon's Inc. You went online and found that the industry consensus on Abilon's equity risk is 1.5. You also know that the company's debt-equity ratio is 2. What is Abilon's estimated business and financial risk based on the model: βE = β A(1 + D/E)?

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