"19. Glynn Enterprises and Monroe, Inc., both produce fluid control products. Their financialinformation is as follows:Capital Structure Glynn MonroeDebt @ 10% ............................................................. $ 1,500,000 0Common stock, $10 per share .................................. 500,000 $2,000,000 $ 2,000,000 $2,000,000Common shares ........................................................ 50,000 200,000Operating PlanSales (200,000 units at $5 each) ............................... $ 1,000,000 $ 1,000,000 Less: Variable costs............................................... 600,000 200,000 ($3 per unit) ($1 per unit) Fixed costs ................................................... 0 400,000Earnings before interest and taxes (EBIT) ............... $400,000 $ 400,000 a. If you combine Glynn’s capital structure with Monroe’s operating plan, what is thedegree of combined leverage? b. If you combine Monroe’s capital structure with Glynn’s operating plan, what is thedegree of combined leverage? c. Explain why you got the results you did in parts a and b. d. In part b, if sales double, by what percent will EPS increase?5-19. Solution:Glynn Enterprises and Monroe, Inc.Q(P - VC) a. DCL = Q(P- VC)-- FC I 200,000 ($5 - $1) = 200,000 ($5-- $1) $400,000- $150,000200,000 ($4) = $200,000 ($4) - $550,000 $800,000 = = 3.20x $250,000 S5-23 5-19. (Continued)Q(P - VC) b.DCL = Q(P- VC)-- FC I 200,000($5 - $3) = 200,000($5- $3)-- 0 0 200,000($2) = 200,000($2) $400,000 = =1x $400,000 c. The combined leverage is fairly high in part a because youare combining firms that both use operating and financialleverage. However, the leverage factor is only one in part bbecause Monroe has no financial leverage and Glynn has nooperating leverage.d. EPS will increase by 100 percent. However, there is noleverage involved. EPS merely grows at the same rate assales.S5-24 20. DeSoto Tools, Inc., is planning to expand production. The expansion will cost $300,000,which can be financed either by bonds at an interest rate of 14 percent or by selling 10,000shares of common stock at $30 per share. The current income statement before expansionis as follows:DESOTO TOOLS, INC.Income Statement200XSales ...............................................................................$1,500,000 Less: Variable costs..................................................... $450,000Fixed costs .........................................................550,000 1,000,000Earnings before interest and taxes..................................500,000 Less: Interest expense .................................................100,000Earnings before taxes .....................................................400,000 Less: Taxes @ 34% .....................................................136,000Earnings after taxes ........................................................$264,000Shares .............................................................................100,000Earnings per share ..........................................................$2.64After the expansion, sales are expected to increase by $1,000,000. Variable costs willremain at 30 percent of sales, and fixed costs will increase to $800,000. The tax rate is34 percent. a. Calculate the degree of operating leverage, the degree of financial leverage, and thedegree of combined leverage before expansion. (For the degree of operating leverage,use the formula developed in footnote 2; for the degree of combined leverage, use theformula developed in footnote 3. These instructions apply throughout this problem.) b. Construct the income statement for the two alternative financing plans. c. Calculate the degree of operating leverage, the degree of financial leverage, and thedegree of combined leverage, after expansion. d. Explain which financing plan you favor and the risks involved with each plan.S5-25 5-20. Solution:DeSoto Tools, Inc.S - VC a. DOL =S-- TVC FC $1,500,000 - $450,000 = = 2.1x $1,500,000- $450,000- $550,000 EBIT DFL = EBIT - I $500,000 = $500,000 - $100,000 $500,000 = =1.25x $400,000 S - TVC DCL = S- TVCF-- CI$1,500,000 - $450,000= $1,500,000- $450,000- $550,000- $100,000 $1,050,000 = = 2.63x $400,000 S5-26 5-20. (Continued)b. Income Statement After ExpansionDebt EquitySales $2,500,000 $2,500,000Less: Variable Costs (30%) 750,000 750,000 Fixed Costs 800,000 800,000EBIT 950,000 950,0001 Less: Interest 142,000 100,000EBT 808,000 850,000Less: Taxes @ 34% 274,720 289,000EAT (Net Income) 533,280 561,0002 Common Shares 100,000 110,000EPS $ 5.33 $ 5.101New interest expense level if expansion is financed withdebt.$100,000 + 14% ($300,000) = $142,0002Number of common shares outstanding if expansion isfinanced with equity.100,000 + 10,000 = 110,000S - TVC DOL = c.S-- TVC FC $2,500,000 - $750,000 DOL (Both) =$2,500,000- $750,000- $800,000 $1,750,000 = =1.84x $950,000 S5-27 "