Degree of Total Leverage Problem

[lebanoncfa]

Hi all...

Check out the following and my inquiry comes at the end:

The following information reflects the projected operating results for Opstalan, a catalog printer.

Sales of $5.0 million.
Variable Costs at 40% of sales.
Fixed Costs of $1.0 million.
Debt interest payments on $1.5 million issued with an annual 7.0% coupon (current yield is 8.0%).
Tax Rate of 0.0%.
Opstalan�s degree of total leverage (DTL) is closest to:

A) 1.41.
B) 1.50.
C) 2.58.
D) 1.59.

In Qbank they calculate Interest expense as current yield (7%) times Debt Outstanding:

Interest Expense = 0.07 * 1,500,000 = 105,000

But the issue is that current yield = Annual Interest Pmt / Bond PRICE

Bond price is the bond's MARKET VALUE and not its Book Value as implied here

I understand that the assumption here is that well market value has not changed from book value...

Am I right or completely off-track and someone may enlighten me?!

 

[bannisja]

Here's my go at it-

DOL = S - VC/S - VC - F = 5 -2/5 -2 -1 = 1.5

DFL = EBIT/EBIT - interest = 2 million/2 million - 105k = 1.05540897

DTL = DOL x DFL = 1.583 so I'm going answer D.

To answer your question, it says: Debt interest payments on $1.5 million issued with an annual 7.0% coupon, so i just took the $1.5 mil x the annual coupon rate of 7% to get my yearly interest payment. I don't think that current yield comes into play, no? I could be wrong on that part... maybe someone else can back it up. on this one, luckily even if I'm wrong and use 8%, i still would get 1.59something as my answer and yield answer D. sometimes better to be lucky than smart?

someone back up that interest calculation- schweser said to use the 1.5 x 7%?

 

[lebanoncfa]

thanks...

u're right... i guess studying at 11 pm is close enough to shutdown time for me ;-)

besides i think they're gonna kick me out from starbucks if i stay longer!

 

[slouiscar]

I have D

S - V / S - V - F - I

(5 - 2) / (5 - 2 - 1 - .105) = 1.58

I is the coupon given @ 7% x par value given as $1.5M issued.