The management of Strings & All, Inc., a small, highly leveraged, electric guitar manufacturer, wants to reduce the company's degree of total leverage (DTL) to
2.0. Currently, the company's expected operating performance is as follows:
To obtain a DTL of 2.0, management must (all else constant):
Click on the arrows to vote for the correct answer
A. B. C. D.C
To obtain this result, we need to calculate the current variable costs, determine the variable costs that will result in a DTL ratio of 2.00, and calculate the percentage change.
Step 1: Calculate current variable costs (VC): VC = 0.6 * 500,000 = 300,000
Step 2: Calculate Variable costs needed to decrease the DTL to 2.0:
Rearranging the formula for DTL:
= (Sales "" Variable Costs) / (Sales "" Variable Costs "" Fixed Costs "" Interest Expense) results in: Variable Costs (VC) = Sales "" (2 * Fixed Costs) "" (2 * Interest Expense)
= 500,000 "" (2*120,000) "" (2*25,000) = 210,000
Step 3: Calculate percentage change:
VC = (300,000 "" 210,000) / 300,000 = 0.30, or 30%.