Chad Gates owns Strings Attached, a store that sells guitars. The company has $5 million in current annual sales, fixed operating costs of $300,000, and $700,000 in variable operating costs, for a total EBT of $2.5 million. The firm has debt of $16,666,666.67, on which it pays 9% annual interest. The degree of combined leverage (DCL) for Strings Attached is 1.72.
1. Calculate the degree of operating leverage (DOL).
2. What is the degree of financial leverage (DFL) for Strings Attached? Calculate your answer using the EBIT and interest expense figures and your knowledge of how DOL and DFL jointly determine DCL.
3. If sales next year increase by 20%, what will be the percent change in net income?