1)Lear, Inc., has \$800,000 in current assets, \$350,000 of which are considered permanent current assets. In addition, the firm has \$600,000 invested in fixed assets. (a)Lear wishes to finance all

1)Lear, Inc., has \$800,000 in current assets, \$350,000 of which are considered permanent current assets. In addition, the firm has \$600,000 invested in fixed assets.

(a)Lear wishes to finance all fixed assets and half of its permanent current assets with long-term financing costing 10 percent. The balance will be financed with short-term financing, which currently costs 5 percent. Lear’s earnings before interest and taxes are \$200,000. Determine Lear’s earnings after taxes under this financing plan. The tax rate is 30 percent.

(a) Earnings after taxes \$

(b) As an alternative, Lear might wish to finance all of its fixed assets and permanent current assets plus half of its temporary current assets with long-term financing and the balance with short-term financing. The same interest rates apply as in part a. Earnings before interest and taxes will be \$200,000. What will be Lear’s earnings after taxes? The tax rate is 30 percent.

(b) Earnings after taxes \$

2)Sharpe Knife Company expects sales next year to be \$1,500,000 if the economy is strong, \$800,000 if the economy is steady, and \$500,000 if the economy is weak. Mr. Sharpe believes there is a 20 percent probability the economy will be strong, a 50 percent probability of a steady economy, and a 30 percent probability of a weak economy.

What is the expected level of sales for the next year?

Expected level of sales \$

3)The Harding Company manufactures skates. The company’s income statement for 2010 is as follows:

HARDING COMPANY

Income Statement

For the Year Ended December 31, 2010

Sales (10,000 skates @ \$50 each) \$ 500,000

Less: Variable costs (10,000 skates at \$20) 200,000

Fixed costs 150,000

Earnings before interest and taxes (EBIT) 150,000

Interest expense 60,000

Earnings before taxes (EBT) 90,000

Income tax expense (40%) 36,000

Earnings after taxes (EAT) \$ 54,000

(a) Compute the degree of operating leverage. (Enter only numeric value.)

Degree of operating leverage

(b) Compute the degree of financial leverage. (Enter only numeric valuerounded to 2 decimal places.)

Degree of financial leverage

(c) Compute the degree of combined leverage. (Enter only numeric valuerounded to 2 decimal places.)

Degree of combined leverage