Question

Ski season just​ ended, however, so the president of the company has started to focus more on the financial aspects of managing the business. He has set up a meeting for next week with the​ CFO, Maria​ Sanchez, to discuss matters such as the business and financial risks faced by the company.

​Accordingly, Maria has asked you to prepare an analysis to assist her in her discussions with the president. As a first step in your​ work, you compiled the information in the popup​ window,

Output level	79,000 units
Operating assets	​3,400,000
Operating asset turnover	6 times
Return on operating assets	31%
Degree of operating leverage	4 times
Interest expense	​520,000
Tax rate	39​%

​, regarding the cost structure of the​ company:

                                               As the next​ step, you need to determine the​ break-even point in units of output for the company. One of your strong points has been that you always prepare supporting work papers that show how you arrived at your conclusions. You know Maria would like to see these work papers to facilitate her review of your work.​ Therefore, you will have the information you require to prepare an analytical income statement for the company. You are sure that Maria would also like to see this statement. In​ addition, you know that you need it to be able to answer the following questions. You also know Maria expects you to​ prepare, in a format that is presentable to the​ president, answers to the following questions to serve as a basis for her discussions with the president.

a. What is the​ firm's break-even point in sales​ dollars?

b. If sales should increase by 20 percent​ (as the president​ expects), by what percentage would EBT​ (earnings before​ taxes) and net income​ increase?

c. Prepare another income​ statement, this time to verify the calculations from part (b​).

a. Before you can compute the​ firm's break-even point in sales​ dollars, you need to compute some items on the​ firm's income statement.

The​ firm's operating assets are 3,400,000 and the operating asset turnover is 6 times. What are the​ firm's sales​ revenues? (Round to the nearest​ dollar.)

The​ firm's operating assets are 3,400,000 and the return on operating assets is 31​%. What is the​ firm's EBIT? (Round to the nearest​ dollar.)

Given the degree of operating leverage of 4 times the sales and EBIT computed in previous​ steps, what are the​ firm's total variable​ costs? (Round to the nearest​ dollar.)

Based on the computed​ sales, EBIT, and variable​ costs, what are the​ firm's total fixed​ costs? (Round to the nearest​ dollar.)

Compute the​ EBT, taxes, and net income to complete the following income statement.  ​(Round up all items to the nearest​ dollar.)  

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	Sales revenues	$20,400,000
	Less: Variable costs	16,184,000
	Less: Fixed costs	3,162,000
	Equals: EBIT	$1,054,000
	Less: Interest expense	520,000
	Equals: EBT
	Less: Taxes (39%)
	Equals: Net income

What is the​ firm's break-even point in sales​ dollars?

​

​b. If sales should increase by 20 percent​ (as the president​ expects), by what percentage would EBT​ (earnings before​ taxes) and net income​ increase?

c. Prepare another income statement to verify the calculations from part (b​).

If sales should increase by 20 percent, what will the forecast level of sales revenues​ be?

Since Variable costs also increase by 20 percent, what is the forecast level of variable​ costs?

Complete the following income statement after the increase in sales.

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	Sales revenues	$24,480,000
	Less: Variable costs	19,420,800
	Less: Fixed costs	3,162,000
	Equals: EBIT
	Less: Interest expense	520,000
	Equals: EBT
	Less: Taxes (39%)
	Equals: Net income

Using the EBT from the two income​ statements, what is the percentage change in the​ EBT?

​%

​(Round to the nearest whole​ percent.)

Answer 1

a) i) Operating assets turnover = Net sales / Operating assets

Here,

Operating assets turnover = 6 times

Operating assets = $34,00,000

Now,

6 times = Net sales / $34,00,000

Net sales = $34,00,000 * 6

Net sales = $2,04,00,000

ii) Return on operating assets = EBIT / Operating assets

Here

Return on operating assets = 31% or 0.31

Operating assets = $34,00,000

Now,

0.31 = EBIT / $34,00,000

EBIT = $34,00,000 * 0.31

EBIT = $10,54,000

iii) Degree of operating leverage (DOL) = (Sales - Variable cost) / EBIT

Here,

DOL = 4 times

Sales = $2,04,00,000

EBIT = $10,54,000

Now, put the values I to formula

4 times = ($2,04,00,000 - Variable cost) / $10,54,000

$10,54,000 * 4 = $2,04,00,000 - Variable cost

$42,16,000 = $2,04,00,000 - Variable cost

Variable cost = $2,04,00,000 - $42,16,000

Variable cost = $1,61,84,000

iv) Fixed cost = Sales - Variable cost - EBIT

Fixed cost = $2,04,00,000 - $1,61,84,000 - $10,54,000

Fixed cost = $31,62,000

v) Income statement :

Particulars	Amount
Sales	$2,04,00,000
Less : Variable cost	($1,61,84,000)
Less : Fixed cost	($31,62,000)
EBIT	$10,54,000
Less : Interest (given)	($5,20,000)
EBT	$5,34,000
Less : Tax @ 39% ($5,34,000 * 39%)	($2,08,260)
Net income	$3,25,740

vi) Break even point in sales = (Fixed cost / Contribution per unit) * Sales price per unit

Here,

Fixed cost = $31,62,000

a) Sales price per unit = Sales / Units

Sales price per unit = $2,04,00,000 / 79,000 units

Sales price per unit = $258.23

b) Variable cost per unit = Variable cost / Units

Variable cost per unit = $1,61,84,000 / 79,000 units

Variable cost per unit = $204.86

c) Contribution per unit = Sales price per unit - Variable cost per unit

Contribution per unit = $258.23 - $204.86

Contribution per unit = $53.37

Now,

Break even point in sales = ($31,62,000 / $53.37) * $258.23

Break even point in sales = $1,52,99,292.86

b) If sales increase by 20%

i) Forcast sales = $2,04,00,000 + 20%

Forcast sales = $2,44,80,000

ii) Forcast variable cost = $1,61,84,000 + 20%

Forcast variable cost = $1,94,20,800

iii) Fixed cost (same) = $31,62,000

iv)New EBT = Forcast Sales - Forcast variable cost - Fixed cost - Interest

New EBT = $2,44,80,000 - $1,94,20,800 - $31,62,000 - $5,20,000

New EBT = $13,77,200

% increase in EBT = (New EBT - EBT) / EBT

% increase in EBT = ($13,77,200 - $5,34,000) / $5,34,000

% increase in EBT = 157.87%

v) New net income = EBT * (1 - Tax rate)

Tax rate = 39% or 0.39

EBT = $13,77,200

Now,

New net income = $13,77,200 * (1 - 0.39)

New net income = $8,40,092

% increase in net income = (New net income - Net income) / Net income

% increase in net income = ($8,40,092 - $3,25,740) / $3,25,740

% increase in net income = 157.90%

c) Forcasted income statement :

Particulars	Amount
Sales	$2,44,80,000
Less : Variable cost	($1,94,20,800)
Less : Fixed cost	($31,62,000)
EBIT	$18,97,200
Less : Interest expense	($5,20,000)
EBT	$13,77,200
Less : Tax @ 39% ($13,77,200 * 39%)	($5,37,108)
Net income	$8,40,092