Degree of operating leverage is the leverage which summarizes the effect of a particular amount of operating leverage on earnings before interest and tax of a company. It involves use of large portions of variable and fixed costs used by the company in its operations. The higher the degree of operating leverage for the company, the more volatile the earnings before interest and tax figure will in relation to change in sakes while all the other things remain constant (Brigham & Gapenski, 1991).
DOL=degree of operating leverage= percentage change in EBIT percentage change in sales percentage change in sales = 500,000*100 =1. 1% 45,000,000 Degree of combined leverage for Glen company question one DOL=3. 5% =2. 18 1. 1% DCL=3. 18*1. 28=4. 07 times The degree of combined leverage at this point is low therefore meaning that the company is not risky at the moment. Degree of combined leverage for Glen company question two DOL=43. 59%= 39. 63 1. 1% DCL=39. 63*12. 45=493. 39times This therefore means that the company has a very high level of risk due to the high level of leverage which increases the fixed costs for the company.
7. Total debt to assets ratio Total debt to assets ratio is the total liabilities of a company divided by the total assets. The ratio is used to show the proportion of the assets of the company which is financed through debt. If the total debt to assets ratio is less than one, it means that most of the assets of the company are financed by equity and if the total debt to assets ratio is greater than one, then it means that most of the company’s assets are financed through debt and companies which have a high total debt to assets ratio are said to be highly leveraged.
This means that such companies are likely to be in danger in case the company creditors starts to demand for repayment for the debts owed to them. Total assets for 2007=40,500,000 total liabilities for 2007= 17,500,000 Therefore the total debt to assets ratio for 2004= 17,500,000 =0. 432 40,500,000 This therefore means that most of the assets of Glen mount company is financed by equity If 10 million of shareholders equity is replaced with debt, then the total debt to assets ratio will be: 27,500,000 =0. 68 40,500,000
This means that most of the company’s assets are stilled financed through equity because the ratio is still less that one. 8. Due to the replacement of the equity of the company by 10 million dollars worth of debt, the stock price of the company is likely to rise. This is because there will be less stock to be bought while the demand will remain the same, this therefore means that the price will rise for the stocks.
Reference: Brigham, E. F. & Gapenski, L. C. , (1991), financial management: theory and practice, Drypen press, ISBN: 0030980666.